Tonga
Recent Economic Developments
Author: International Monetary Fund
Publication Date:
09 Jan 2001
eISBN:
9781451837421
Language:
English
Keywords:
ISCR; CR; Tongan authorities; public enterprise; interest rate; central bank; real GDP
Download PDF (2.2 MB)

This report analyzes the recent economic developments of Tonga by assessing the potential output, prices, employments, production by sectors, and private sector development policy. The paper describes the public finance, budgetary process and structure of the budget, public enterprises, and privatization. The paper reviews the banking supervision and bank soundness, money and credit development, and monetary policy objective of the national reserve bank of Tonga. The study also provides the details of the foreign reserves and exchange rate, current transfers, capital account, and debt of the country.

Abstract

This report analyzes the recent economic developments of Tonga by assessing the potential output, prices, employments, production by sectors, and private sector development policy. The paper describes the public finance, budgetary process and structure of the budget, public enterprises, and privatization. The paper reviews the banking supervision and bank soundness, money and credit development, and monetary policy objective of the national reserve bank of Tonga. The study also provides the details of the foreign reserves and exchange rate, current transfers, capital account, and debt of the country.

I. Overview

1. Tonga is an archipelago, located on the dateline 1,500 kilometers south of the equator, comprising 36 inhabited islands scattered over 1,000 kilometers of ocean. Its population of about 100,000 enjoys a middle-income standard of living (with a per capita GDP in 1999/00 of about US$1,500). Tonga is a constitutional monarchy in which substantial powers are assigned to the King and the nobility; the government is large with its spending amounting to about 30 percent of GDP. The economy is open and heavily dependent on grants and remittances; it shares a number of characteristics with other island economies such as remoteness, openness, susceptibility to natural disasters, limited diversification, small domestic market, narrow resource base, and scarcity of skilled labor.

2. Tonga is an agriculture-based economy. A vast majority of families own plots of land in which they grow a large portion of their food requirements. In addition, some crops are grown for export. In the early 1990s, Tonga’s real GDP growth enjoyed a temporary boost from its success in exporting squash to Japan, However, ineffective production arrangements, marketing problems, shortage of crop financing, and growing foreign competition have contributed to a drop in squash production since its peak in 1993/94. Accordingly, the economy reverted back to its trend growth of about 1–2 percent during 1994/95–1997/98.1 Moreover, prices in the Japanese squash market collapsed in 1999, bankrupting some growers and leading others to shift to other activities.

3. Real GDP growth in 1998/99 and 1999/00 is estimated at 3½ percent and 5½ percent, respectively. In 1998/99, the increased production of processed food and building materials more than compensated for the decline in agricultural output, which was severely affected by Cyclone Cora in December 1998. Growth in 1999/00 was led by a large increase in the trade and services sector related to the millennium celebration events, together with the income effect from increased workers’ remittances. Growth was also supported by a rebound in agricultural production. Inflation rose to about 4 percent in 1998/99 (period average) attributed mainly to drought and higher world prices. Upward adjustment in tobacco prices was the main cause behind the further increase in inflation to 5½ percent in 1999/00.

4. Macroeconomic policies were geared toward maintaining stability in 1998/99–1999/00. Fiscal deficits were kept low with little recourse to domestic bank financing as the implicit fiscal rule of maintaining a zero recurrent balance was broadly adhered to. While private sector credit growth was contained, net domestic assets rose by 30 percent in 1999/00. The external position worsened substantially in 1999/00, reflecting rapid growth in imports and a few bulky one-off transactions. In addition, the capital account worsened as official loans declined further. Accordingly, foreign reserves declined from 3½ months of imports at end-1998/99 to below 2½ months of imports at end-1999/00.

II. Output, Prices, and Employment

A. Production by Sectors

5. The Tongan economy has a large services sector that accounts for more than half of total output. Government services followed by commerce, restaurants, and hotels are the main components of the sector. The primary sector, accounting for about a quarter of total output, is vulnerable to weather conditions and thus has been the main source of output fluctuations (Tables 1 and 2).

Table 1.

Tonga: Real Gross Domestic Product by Sector of Origin, 1995/96–1999/00

(In 1995/96 Prices)

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Sources: Data provided by the Tongan authorities; and Fund staff estimates.
Table 2.

Tonga: Nominal Gross Domestic Product by Sector of Origin, 1995/96–1999/00

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Sources: Data provided by the Tongan authorities; and Fund staff estimates.

Agriculture

6. Key agricultural products for domestic consumption are root crops such as yam, cassava, taro, and sweet potato, while squash is the main agricultural product for export. Indices of agricultural production show that 1996/97–1997/98 was a particularly bad period for exports as production of root crops, which are predominantly affected by the supply side such as weather conditions, outperformed production of export crops, which depend more on demand conditions (Figure 1). Fluctuation of agricultural production in recent years for domestic consumption was somewhat dampened in value terms by the opposite movement in the unit values of these products (Table 3). Agricultural products for both domestic consumption and export rebounded in 1999/00 after having declined significantly in 1998/99 in volume terms.

Figure 1.
Figure 1.

Tonga: Real Sector Indicators, 1995/96–1999/00

Citation: IMF Staff Country Reports 2001, 002; 10.5089/9781451837421.002.A001

1/ Based on agricultural products sold in Talamahu market (the main market in Tonga for agricultural products).2/ Data for 1999/00 are staff estimates based on the actual data for the first half of the fiscal year.
Table 3.

Tonga: Agricultural Products Marketed in Tonga, 1995/96–1999/00 1/

(1987/88=100)

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Sources: Data provided by the Tongan authorities; and Fund staff estimates.

Data reflect agricultural products sold in Talamahu market.

For 1999/00, percent change calculated on the same period in 1998/99.

Fisheries

7. The fishery industry grew steadily throughout the 1990s to become an important source of foreign exchange earnings second only to squash. Receipts of fish exports grew from US$1 million in the early 1990s to about US$4 million more recently. The fishery industry is vulnerable to weather conditions, and its exports are constrained by limited transportation; a small amount of fish with a high unit value is exported using commercial airlines. Main exports are tuna, snapper, and grouper. The tuna catch has grown rapidly in the last two years, and now accounts for about one-half of total fish exports in value terms. About 30 percent of the fresh tuna catch is exported to Japan, 20 percent to Korea, and the remainder is exported to the United States, particularly Hawaii.

8. The government is sponsoring the growth of the fishery industry. In 1997, the Food and Agriculture Organization (FAO) and the Australian governmental aid organization (AusAID) conducted a sector review and made recommendations in five areas: (i) shore resource management; (ii) tuna long-line fishing; (iii) small-scale fishing; (iv) pearl industry development; and (v) aquaculture development. These recommendations helped the Ministry of Fishery refocus its policy priorities. In 1998, the government started to redraft the Fishery Act, with assistance from FAO, with the goal of complying with regional initiatives to manage fisheries, especially relating to tuna. The draft legislation is expected to be presented to parliament in 2001. Fishing licenses were issued to foreign companies starting in 1999 and the sector is expected to benefit from foreign direct investment.

Tonga: Developments in Agricultural Products for Export

With fertile land, Tonga has an advantage in producing agricultural products. However, remoteness from large foreign markets hampers development of cash crops. Tonga’s agricultural exports can be classified into two categories: (i) the traditional root crops; and (ii) cash crops developed mainly for export.

Traditional root crops include taro, yam, and cassava. These crops are consumed by Tongans living abroad who purchase them in small quantities for personal consumption. Accordingly, exports of these products have been rather stable and limited, accounting for only about 5 percent of total agricultural exports.

The main cash crop has changed over time, initially from banana to coconut, and vanilla; since the late 1980s, squash has been the main crop. These changes over time were brought about by greater competition worldwide and a collapse of world prices of the respective products. Squash production was introduced to Tonga by a New Zealand firm in 1988 and soon became the most important product accounting for about 45 percent of total agricultural exports. Profitability of squash, however, has declined due to a drop in its price. The Tongan government once introduced quotas in an attempt to achieve higher export prices, but failed to sustain prices while discouraging output.

Tonga is trying to diversify its agricultural products for export. The most promising product is kava, which is currently exported to Fiji, New Zealand, and the United States. In addition, demand from European pharmaceutical manufacturers has increased steadily since 1996. However, there are constraints to its expansion, such as obtaining access to areas with suitable soil and having sufficient quantity of planting materials.

9. Tonga is reported to have abundant fish resources owing to its location, and to not having exploited those resources to the same extent as some of its neighboring countries. The Tongan authorities are mindful of conserving its fish resources and are actively involved in regional multilateral arrangements for managing tuna stocks.

10. In addition to fish, there are other sea-related export products. In 1998, Sea Star, the largest domestic fishing operation jointly owned by the Tongan government, and Japanese and Tongan private companies, started mozuku cultivation. Its main market is Japan, and exports are expected to grow rapidly. Currently the company produces 400 tons of mozuku, and it plans to raise the production level to 600 tons in 2000/01 and to 2,000 tons in five years.

Manufacturing and construction

11. Starting in the late 1970s, the government made significant efforts to develop manufacturing. Enactment in 1978 of the Industrial Development Incentives (IDI) Act was the first step. The establishment in 1980 of the Small Industries Center to assist with buildings, utilities, and infrastructure facilities for industry was a second step. Earlier, the Tonga Development Bank (TDB) had been set up to assist export-oriented businesses by providing loans at below-market interest rates. Despite these efforts, the share of manufacturing in GDP has not grown significantly over the past 20 years. The boost to manufacturing provided by the IDI Act proved temporary because a number of companies disappeared after their tax holidays expired.

12. Manufacturing has grown steadily only in the last three years, averaging about 10 percent of annual growth. In 1998/99, production of processed food and building materials for construction increased, which offset a fall in agricultural production. However, the domestic market for locally manufactured and assembled goods remains very small. With respect to foreign markets, the international competitiveness of manufactured products suffers from high operating costs, especially in utilities and transportation, delays in obtaining approvals, high duty rates, and shortages of skilled labor. Moreover, labor costs are reported to be high in comparison to Southeast Asian economies.

13. Construction activity is influenced heavily by externally financed development projects. In 1998 and 1999, some major projects were completed, including the National Council of Churches Center, the Nafanua market in ‘Eua, estimated at US$0.9 million and US$0.5 million, respectively, the Wesleyan Church administration center, school buildings for the Niua’s funded by the New Zealand government, and a business center for Tupou High School. Furthermore, infrastructure projects in Vava’u, including new customs and market buildings, improvement of the urban water drainage and the wharf, and the reconstruction of the roads in Neiafu, were concluded. In 2000, a new project funded by Japan to improve the water system in Tonga was commenced and is expected to continue for two years.

14. The tertiary sector recorded an average growth rate of 4 percent during 1997/98–1999/00. Accounting for more than half of total value-added in Tonga, this sector contributed significantly to recent real GDP growth. The biggest component is government services, which expanded by 9 percent and 1½ percent in 1998/99 and 1999/00, respectively. Commerce, restaurants, and hotels, which are related to tourism, are the most important private sector services. Transportation and communications, and finance and real estate are also large components.

15. Tourism jumped in 1999/00 following weak growth in the previous year (Table 6). This growth was related, but not limited, to the millennium celebration events in the fourth quarter of 1999. The increase in the number of tourist arrivals, which started in 1999/00 is continuing in 2000/01. Growth of the tourism sector is constrained by limited accommodation in terms of both quantity and quality, although some renovations are taking place and a few hotels are being built. The turmoil in Fiji in May 2000 has not adversely affected Tonga’s tourism, counter to initial expectation as Fiji is regarded often as the main gateway to Tonga. The Fiji turmoil could have a permanent and positive impact on Tonga’s tourism if more short-haul tourists from Australia or New Zealand, which currently account for 50 percent of Tonga’s tourists, were to regard Tonga as a safe alternative to Fiji. On the other hand, the number of tourists from the United States, Europe, and Asia could drop as they are not very familiar with regional developments and, therefore, tend to group Tonga together with Fiji as a country in an unstable region.

Table 4.

Tonga: Production of Manufactured Goods, 1995/96–1999/00

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Sources: Data provided by the Tongan authorities; and Fund staff estimates.

Other industries include chemicals and chemical products, manufacture of wood products, machinery, and equipment.

For 1999/00, percent change calculated over the first six months in 1998/99.

Table 5.

Tonga: Indicators of Economic Activity, 1995/96–1999/00

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Sources; Data provided by the Tongan authorities; and Fund staff estimates.

For 1999/00, percent change calculated over the first nine months in 1998/99.

Table 6.

Tonga: Tourism Statistics, 1995/96–1999/00

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Sources: Data provided by the Tongan authorities; and Fund staff estimates.

Including passengers and crew members.

Sum of air passengers and cruise passengers.

Data from Overseas Exchange Transaction (OET) records.

Based on surveys by the Tonga Visitors’ Bureau; figures may differ from the OET data.

16. The government considers tourism as one of the three most promising industries in the latest development plan, the other two being fishery and agriculture. AusAID has been assisting the Tongan government for the last two years to develop the tourism industry through a three-year project. The aim of the project is to improve the quality of the industry as well as to advertise and promote Tonga as a potential destination, including through creating a Web site.

B. Prices and Wages

Prices

17. Inflation rose to about 4 percent in 1998/99, attributed initially to drought, and followed by higher world prices. To a lesser extent, the lagged effect of the close to 20 percent nominal exchange rate depreciation vis-à-vis the U. S. dollar in 1997/98 also contributed to the price increase. Upward adjustment in tobacco prices by 20 percent was the main cause behind the further increase in inflation to 5½ percent in 1999/00 (Table 7).

Table 7.

Tonga: Consumer Price Index, 1995/96–1999/00

(Annual average)

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Sources: Data provided by the Tongan authorities; and Fund staff estimates.

18. The composition of the CPI basket reflects the 1992/93 Household Income and Expenditure Survey. Key items in the basket are food (43 percent), transportation (15 percent), and household goods (14 percent). The CPI basket is also divided into domestic and imported components. The imported component has a larger weight (54.2 percent) than the domestic component. Since the share of imported consumption goods in total consumption is high, Tonga’s prices track relatively closely its trading partner’s price changes.

Labor market and wages

19. A steady emigration has kept the population growth to less than one percent per year. As emigrants include skilled labor, current demographic developments have led to local shortages of certain types of workers. Most Tongans emigrate to the United States, Australia, and New Zealand. With the recent tightening of rules regarding immigrants in these countries, the number of new emigrants is expected to decline in the future. Information on recent developments in the labor market is not available since the last labor force survey took place in 1996 and the next one is planned for 2001 (Table 8).

Table 8.

Tonga: Population and Labor Market, 1993–99

(In persons, unless otherwise specified)

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Sources: Data provided by the Tongan authorities; and Fund staff estimates.

C. Private Sector Development Policy

20. Businesses require a license to operate that is issued based on the applicant’s nationality, a proposed business plan, and financial references. The business license is a de facto regulatory mechanism control applied on a discretionary basis that could discourage foreign involvement. Investment income is subject to various taxes: corporate and individual income tax, import tax (including ports and services tax), excise duty, and sales tax. Income tax is applied to salaries and wages, and dividends and interest income are subject to withholding taxes.

21. A set of investment incentives is provided, largely tax holidays and duty exemptions and concessions. Investment privileges, under the IDI Act, are secured by obtaining a development license.2 The Standing Committee, which advises on the issuance of such licenses, normally specifies the incentives to be offered. It has wide discretionary powers in issuing licenses and approving incentives. For foreign investment, the committee is required to determine the desirability of the investment based on several factors including export potential, import substitution, level of local equity participation, labor/capital ratio, and technology transfer.

22. The current licensing system fails to provide a clear framework on which investors can make decisions. Moreover, the tax system imposes a high burden on investment income in comparison with its regional competitors. This is well illustrated by the level of import duties imposed on capital items; the 42½ percent corporate tax rate and the 15 percent withholding tax on distributed dividends raise the effective tax rate applied to distributed income to above 50 percent.

23. The authorities plan to streamline licensing procedures, including through: (i) removing the scope for discretion in the process by the licensing officer; (ii) developing and using a negative list of sectors or business activities for which business licenses cannot be issued; (iii) rationalizing the extensive list of conditions associated with the granting of licenses to particular business types; (iv) simplifying the application process, including the removal of the unnecessary information requirements; and (v) reviewing the licensing process to consolidate and simplify.

24. Current tax reform proposals include: (i) a progressive income tax structure with a redefined threshold income, abolition of numerous deductions, and removal of withholding tax on dividends and interest; (ii) a single corporate income tax rate for both foreign and domestic companies at or close to the maximum personal rate; (iii) a simplified lower tariff structure centered around a uniform low rate with a higher rate for only a narrow class of luxury items; and (iv) a broadened uniform sales tax or equivalent to include services as a transition to a VAT-type structure, and abolition of the existing fuel sales tax.

III. Public Finance

A. Overview

25. The public sector plays a dominant role in Tonga. Total central government revenue and grants have averaged about 30 percent of GDP over the past five years, while total expenditure has been slightly higher. In addition, the public enterprise sector is large and diverse, comprising of enterprises engaged in a wide range of activities (e.g., utilities, tourism, transportation, banking, and fishing). As a result, the government is also a major employer in the economy.

B. Recent Developments

26. Fiscal policy in recent years has been generally prudent. The overall balance, on a Government Finance Statistics basis, swung from a deficit of 4.8 percent of GDP in 1996/97 into a surplus of 0.8 percent of GDP in 1999/00. The sharp improvement is largely a result of lower capital expenditure, and to a lesser extent, increased tax revenues due to higher imports (Table 9). The large variation in deficits reflect the availability of foreign financing that is related to capital expenditure rather than an intentional fiscal stance of the government.3 Moreover, the unusually high level of capital expenditure and unidentified financing in 1996/97 are most likely the result of a misclassification of grants-in-kind.

Table 9.

Tonga: Central Government Fiscal Operations, 1995/96–1999/00

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Source: Data provided by the Tongan authorities.

The data for 1995/96 and 1996/97 was originally provided in a non-GFS format, thus the lack of information for certain items.

The Ministry of Finance does not compile financing data in a GFS format. The large discrepancies arise as the financing items comes from different sources (e.g., monetary statistics).

27. Tax revenues rose by T$10 million over the past four years, reaching T$52.9 million in 1999/00 (Table 10). Most of the increase occurred in the last two fiscal years, where higher collection of trade taxes accounted for over 70 percent of the increase. Nontax revenues declined by T$2.2 million over the same period, mostly due to a drop in the collection of administrative fees and charges, which was partially offset by higher entrepreneurial and property income. Grants-in-cash has been declining over the past four years, partly due to donors’ increasing preference for paying suppliers of goods and services directly.

Table 10.

Tonga: Central Government Revenue, 1995/96–1999/00

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Source: Data provided by the Tongan authorities.

The data for 1995/96 and 1996/97 was originally provided in a non-GFS format, thus the lack of information for certain items.

28. Current expenditure rose by T$10.6 million over the past four years, reaching T$66.2 million in 1999/00 (Table 11). The main cause of the increase was larger outlays for wages and salaries, including a 5 percent cost of living adjustment granted to offset the impact on take-home pay of the new retirement scheme introduced on July 1, 1999 and the cost of the employer contribution to the scheme (see below). Capital expenditure, excluding grants-in-kind, declined over the period to T$5.6 million (less than 2.5 percent of GDP) in 1999/00. This decline is the result of donors’ increasing preference for paying suppliers directly, as noted above, and the lesser use of external loans to finance investment.

Table 11.

Tonga: Central Government Expenditure by Economic Classification, 1995/96–1999/00

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Source: Data provided by the Tongan authorities.

The data for 1995/96 and l996/97 was originally provided in a non-GFS format, thus the lack of information for certain items.

29. Public debt outstanding at end-1999/00 is estimated to be 47 percent of GDP, with domestic debt accounting for 6 percent and external debt (mostly concessional) for 41 percent of GDP (Table 14). At present, the entire domestic debt is in the form of bonds held mainly by banks and, to a lesser extent, by the nonfinancial public and private sector. Additionally, the government has a large unfunded legal liability on account of obligations under the new retirement scheme for civil servants. This liability is estimated at T$30 million.

Table 12.

Tonga: Central Government Current Expenditure by Functional Classification, 1995/96–1999/00

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Source: Data provided by the Tongan authorities.