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© 2007 International Monetary Fund

August 2007

IMF Country Report No. 07/297

Tonga: 2007 Article IV Consultation—Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2007 Article IV consultation with Tonga, the following documents have been released and are included in this package:

  • The staff report for the 2007 Article IV consultation, prepared by a staff team of the IMF, following discussions that ended on April 20, 2007, with the officials of Tonga on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on June 25, 2007. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF.

  • A supplement on the joint IMF/World Bank debt sustainability analysis.

  • A Public Information Notice (PIN) summarizing the views of the Executive Board as expressed during its July 11, 2007 discussion of the staff report that concluded the Article IV consultation.

The document listed below has been or will be separately released.

  • selected Issues Paper and Statistical Appendix

The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information.

To assist the IMF in evaluating the publication policy, reader comments are invited and may be sent by e-mail to publicationpolicy@imf.org.

Copies of this report are available to the public from

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Price: $18.00 a copy

International Monetary Fund

Washington, D.C.

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INTERNATIONAL MONETARY FUND

TONGA

Staff Report for the 2007 Article IV Consultation

Prepared by the Staff Representatives for the 2007 Consultation with Tonga

Approved by Steven Dunaway and Anthony Boote

June 25, 2007

Discussions: Nuku’alofa, April 11–20, 2007. The team met with Prime Minister Sevele, Minister of Finance ‘Utoikamanu, National Reserve Bank of Tonga Governor Mafi, and other senior government officials.

Team: Messrs. D’Hoore (head), and Mses. Amornvivat and Fujita (all APD). Mr. Gordon (APD) and Ms. Sucharitakul (OED) joined the discussions.

Political and Economic Context: Tonga, a constitutional monarchy with substantial powers assigned to the King and the nobility, is in the midst of a difficult transition. Prodemocracy riots broke out in the capital city in November 2006, resulting in extensive damage and disruptions to economic activity. On the policy front, a 70 percent wage award to civil servants in 2005, and a large redundancy program in 2006, have put strains on the budget.

Exchange Rate: Tonga’s currency, the pa’anga, is pegged to a basket of currencies (comprising the US, Australian, and New Zealand dollars, and the yen), with the arrangement allowing monthly deviations of up to 5 percent from the peg. Tonga has accepted the obligations of Article VIII, Sections 2, 3, and 4. Tonga presently imposes an exchange restriction subject to approval under Article VIII, Section 2(a), in the form of tax certification requirement imposed on certain current international transactions.

Outreach: Staff met with business leaders, donors, and representatives of the diplomatic corps.

Statistical Issues: Tonga’s data quality remains hampered by deficiencies that complicate surveillance of policies.

Contents

  • Executive Summary

  • I. The Country Context

  • II. Economic Developments and Outlook

    • A. Recent Developments

    • B. Medium-Term Outlook and Risks

  • III. Policy Discussions

    • A. Fiscal and Debt Policy

    • B. Monetary, Financial and Exchange Rate Policies

    • C. Structural Reforms and Other Issues

  • IV. Staff Appraisal

  • Boxes

  • 1. The Civil Service Wage Settlement

  • 2. Remittances in Tonga

  • 3. Comprehensive Tax Reform

  • Figures

  • 1. Regional Comparators (Averages, 2001–06)

  • 2. Regional Fiscal Comparisons

  • 3. Real, Fiscal, and Monetary Sector Developments, 1999/2000–2006/07

  • Tables

  • 1. Selected Economic Indicators, 2002/03–2007/08

  • 2. Summary of Government Operation, 2002/03–2007/08

  • 3. Banking Survey, 2002/03–2006/07

  • 4. Balance of Payments Summary, 2002/03–2007/08

  • 5. Medium-Term Scenario, 2004/05–2011/12

  • 6. Banking Sector Indicators, 2001–06

  • 7. Progress on Millennium Development Goals

Executive Summary

Background

  • The economy has experienced large shocks. Following the 70 percent civil service wage award in late 2005, almost 20 percent of civil servants took voluntary redundancy in mid-2006, at large cost to the budget. Riots in November 2006 caused serious damage to the capital city’s business district, and disrupted economic activity. Real GDP is projected to fall by 3½ percent in the fiscal year ending in June 2007. Yet the economy appears to be recovering; and inflation has continued to decline, owing largely to a tight credit policy and the maintenance of a basket peg.

  • Cautious conduct of fiscal and monetary policy has helped to contain the negative impact of the wage settlement. The strains on the fiscal position due to the wage settlement and redundancy payments were partly contained through expenditure restraint and large revenue gains. Despite revenue losses in the wake of riots, the authorities have maintained their deficit target for the year. Monetary policy succeeded in reining in high private credit growth in 2006, and has since been eased.

  • Significant threats to debt sustainability have emerged. The authorities are seeking a possible $50 million (20 percent of GDP) loan to finance reconstruction projects. This and other loans’ debt service requirements would place serious strain on the medium-term fiscal and external positions.

Key Policy Issues

Against this background, the staff recommended that the authorities:

  • Capitalize on recent gains to place fiscal policy on a sustainable track, by sustaining revenue gains, resisting pressures on the wage bill, and ensuring that non-wage spending is prioritized. The authorities should consider scaling back external borrowing plans that would heighten medium-term risks of debt distress.

  • Closely monitor credit developments. While the recent easing of policy to accommodate reconstruction-related credit is understandable, the external position remains fragile. Monetary tightening may become necessary, particularly if new fiscal pressures emerge, and the authorities should make greater use of the flexibility in the foreign exchange regime to counter real exchange rate appreciation.

  • Accelerate the pace of implementation of structural reforms to improve the business environment for the private sector and make the economy more dynamic.

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INTERNATIONAL MONETARY FUND AND INTERNATIONAL DEVELOPMENT ASSOCIATION

TONGA

Joint IMF/World Bank Debt Sustainability Analysis 20071

Prepared by the staffs of the International Monetary Fund and The International Development Association

Approved by Anthony Boote and Steven Dunaway (IMF) and Deepak Bhattasali and Vikram Nehru (IDA)

June 22, 2007

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INTERNATIONAL MONETARY FUND

TONGA

Staff Report for the 2007 Article IV Consultation—Informational Annex

Prepared by the Staff Representatives for the 2007 Consultation with Tonga

(In Consultation with Other Departments)

June 15, 2007

Contents

  • I. Fund Relations

  • II. Relations with the Pacific Financial Technical Assistance Centre

  • III. Relations with the World Bank Group

  • IV. Relations with the Asian Development Bank

  • V. Statistical Issues

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Public Information Notice (PIN) No. 07/102

FOR IMMEDIATE RELEASE

August 13, 2007

International Monetary Fund

700 19th Street, NW

Washington, D. C. 20431 USA

Tonga: 2007 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion
Author: International Monetary Fund