Tonga: Joint IMF/World Bank Debt Sustainability Analysis 2009
Author: International Monetary Fund
Publication Date:
22 Sep 2009
eISBN:
9781451837513
Language:
English
Keywords:
ISCR; CR; staff appraisal; staff representative; loan; agreement; debt position; burden indicator; creating flow; public sector debt Sustainability framework; debt stock; Debt sustainability analysis; Public and publicly-guaranteed external debt; Public sector; Global
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Tonga’s growth is likely to be low in the near term as remittances remain constrained by global economic conditions. The staff report for Tonga’s 2009 Article IV Consultation highlights economic developments and policies. The reconstruction of the central business district and increased subsistence agriculture are likely to cushion the downward pressures. Risks are, however, tilted to the downside, mainly owing to increasing unemployment in remittance-sending economies and rising oil prices. The drawdown of the large reconstruction loan will lead to high risk debt levels over the medium term.

Abstract

Tonga’s growth is likely to be low in the near term as remittances remain constrained by global economic conditions. The staff report for Tonga’s 2009 Article IV Consultation highlights economic developments and policies. The reconstruction of the central business district and increased subsistence agriculture are likely to cushion the downward pressures. Risks are, however, tilted to the downside, mainly owing to increasing unemployment in remittance-sending economies and rising oil prices. The drawdown of the large reconstruction loan will lead to high risk debt levels over the medium term.

I. Background

1. The external and public debt sustainability analyses are based on the standard LIC DSA framework.2 The DSA presents the projected path of Tonga’s external and public sector debt burden indicators, and draws some conclusions on the forward-looking sustainability of debt.

2. Tonga’s total public sector debt stock (including publicly guaranteed debt) declined to 34 percent of GDP in FY07/08 from 40 percent of GDP in 2005/06. External debt to GDP fell as donor financing declined in real terms, while fiscal consolidation to limit domestic budget financing also contributed to a downward trend in domestic public debt to GDP.

3. Following the civil unrest in November of 2006, the government made a significant effort toward securing financing for the reconstruction of the capital city of Nuku’alofa. This includes donor grants of about US$15 million, to be channeled through designated banks to business entities affected by the riots in the form of off-budget, low interest rate loans in the second half of 2007/08. The government also signed a long-term reconstruction loan from the EXIM Bank of China in November 2007. Disbursements of this loan were postponed, as the government sought to ensure it was used productively and negotiated for use of local inputs. The first drawdown was made in April 2009. Loan proceeds will be used in broadly equal measure to finance public works in the capital and to lend to the private sector for office and retail construction. The loan, which bears a 2 percent interest rate will be repaid over 20 years with a 5 year grace period.

4. The 2009 DSA reinforces the findings of the previous analysis. The main changes from the 2008 DSA are the lower short-term growth outlook as a result of the global economic crisis and more rapid assumed drawdowns of the EXIM Bank loan. In addition, the DSA incorporates the authorities’ new GDP statistics. The new series has improved coverage and, includes estimates of the informal sector. This increases the level of GDP by 15–20 percent and causes some changes to historic growth rates. While the increase in the level of GDP reduces historic debt ratios, it has not led to a change in the assessment of Tonga’s risk of debt distress.

Key Macroeconomic Assumptions

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II. Baseline

5. Tonga’s DSA builds on the baseline scenario assumptions presented in Box 1. It assumes that the real GDP growth rate will revert close to its historical average following a slowdown in 2008/09 and 2009/10. The reconstruction loan will be drawn down over four years. Excluding reconstruction spending, public spending will be broadly limited to projected revenues and grants over the medium term, and will, thus, minimize additional external borrowing. Although exports are expected to remain constrained, remittances, which are the largest source of foreign exchange earnings (one half of Tongans live abroad, mostly in Australia, New Zealand, and United States), are expected to remain an important external cushion over the medium term.

Key Assumptions

  • Real GDP growth is projected to average 1.2 percent over the period 2009/10-2014/15, reflecting a slowdown from the global financial crisis in the first two years and an average of 1¾ percent thereafter. This modest long-run growth outlook is in line with Tonga’s historic growth rates, reflecting structural impediments, which will continue to constrain growth potential.

  • Inflation as measured by the GDP deflator is projected to average 5 percent over the projection period 2009/10-2014/15.

  • The non-reconstruction public sector budget is projected to remain broadly balanced. Fiscal revenue is projected to grow steadily before it stabilizes at around 26 percent of GDP, as improvements in tax administration bed in and compliance improves.

  • Grants are projected to decline from current high levels, but remain significant at around 2 percent of GDP over the medium term. This reflects the importance of donor commitments given the relatively small size of the Tongan economy. The EXIM Bank reconstruction loan is assumed to be fully drawn down by 2012/13 and no major further infrastructure lending is assumed.

  • Total expenditure is projected to remain below revenues and grants, yielding primary surpluses of around 1 percent of GDP, somewhat smaller than recent outturns.

  • The external current account balance is projected to decline this year to 7.9 percent of GDP from 10 percent of GDP in 2007/08 driven largely by the drop in food and fuel prices. Over the medium term, the deficit should stabilize around 6 percent of GDP.

  • FDI is projected to stabilize below recent levels at around 6–7 percent of GDP.

  • The export base is projected to remain narrow and relatively undiversified, while remittances have recently dropped as a result of the decline in economic activity in the United States and New Zealand, from which the greater part of remittances emanate. They are, however, expected to recover as these economies rebound from the impact of the global economic slowdown, including seasonal worker programs in Australia and New Zealand.

III. External DSA

Baseline

6. Under the baseline, the external debt trajectory breaches the policy-dependent threshold in 2009/10 before receding to below the threshold in 2018/19. Public and publicly guaranteed (PPG) external debt averaged over 30 percent of GDP from 1998 to 2006, the indicative threshold level, but has decreased in recent years reflecting growth in nominal GDP and fiscal prudence. However, with the drawdown of the reconstruction loan the PV of PPG external debt is projected to increase to about 42 percent of GDP by 2012/13, 12 percent above the threshold, before dropping under the threshold in 2017 and declining to 11 percent of GDP by the end of the projection period.

7. External debt remains well above the PV of debt-to-export distress threshold. Reflecting Tonga’s low exports, the NPV of PPG external debt-to-exports ratio is 243 percent, well above the indicative threshold of 100 percent, and is projected to remain above the threshold for an extended period. However, this is mitigated in part by the large remittances, which are the largest source of foreign exchange earnings (one half of Tongans live abroad, mostly in Australia, New Zealand, and the United States) and which have a countervailing effect by helping to reduce liquidity risks.

Tonga: External Public Debt Indicators

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Represents Low Income Country DSA indicative thresholds for Tonga that is classified as a poor performer under the World Bank’s Country Policy and Institutional assessment.

8. Debt and debt service are expected to stay above the exports threshold for the majority of the projection period. The impact of the global economic crisis will make it harder for Tonga to expand its very narrow export base in the short term, aggravating solvency and liquidity risks. Remittances will decline in the short term, but they are expected to recover and stabilize at around 25 percent of GDP over the medium term, considerably below historical highs, but still providing a vital cushion against external debt distress and liquidity risks. Moreover, the ratio of debt and debt service to revenue remain well below the thresholds of 200 percent and 25 percent, respectively, throughout the projection period (Figure 1a), albeit with a deterioration in the short- to medium term.

Figure 1.
Figure 1.

Tonga: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2008–2028 1/

Citation: IMF Staff Country Reports 2009, 292; 10.5089/9781451837513.002.A002

Source: Staff projections and simulations.1/ The most extreme stress test is the test that yields the highest ratio in 2018. In figure b. it corresponds to a One-time depreciation shock; in c. to a Exports shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in picture f. to a One-time depreciation shock

Alternative scenario and stress tests

9. Stress tests show the vulnerability of the debt position to a slowdown in exports or a significant depreciation. The export shock stress test causes the present value of debt to reach 600 percent of exports and remain above the 100 percent threshold for the entire projection period. Similarly debt service to exports ratios rise even further above the 15 percent threshold, reaching over 40 percent in 2015. A one time depreciation causes the present value of debt to rise to 60 percent of GDP and remain above the 30 percent threshold until 2022. It also causes the present value of debt to revenue ratio to briefly breach threshold. Similarly public sector borrowing on less favorable terms would see debt levels remain above the indicative GDP threshold for a prolonged period and approach the revenue threshold.

IV. Public Sector DSA

Baseline

10. The public sector DSA reinforces the conclusions of the external DSA. In the last two fiscal years, Tonga’s public debt to GDP ratio has declined to around 34 percent of GDP. However, the resumption of large scale public sector borrowing for reconstruction of the capital reversed the trend, with debt building up to 44 percent of GDP in 2010/11 before declining steadily thereafter under the baseline scenario. This reflects the importance of fiscal prudence, and a continued commitment to limit new public borrowing.

Alternative scenario and stress tests

11. Stress tests reflect that vulnerabilities remain throughout the projection period, particularly to low GDP growth. Among the stress tests performed, the permanent decline in GDP growth and a one-standard deviation decline in GDP growth show the strongest deterioration, with the PV of debt to GDP ratio rising above 50 percent of GDP in both cases. Further, the alternative scenario in the public sector DSA shows that the additional large public sector borrowing for infrastructure currently being envisaged causes prolonged increases in debt levels.

V. Staff Assessment

12. Tonga remains at a high risk of external debt distress. At the same time, Tonga benefits from very high remittance inflows, which are the largest source of foreign exchange earnings and have a countervailing effect by helping to mitigate liquidity risks. Moreover, Tonga’s overall public sector debt dynamics, while elevated over the short term, shows a decreasing trend over the longer run, suggesting that debt dynamics are manageable, but at high risk.

13. Stress tests highlight key vulnerabilities to debt sustainability over the medium term, including lower GDP growth, major external shocks, and borrowing on less concessional terms. This underscores the importance of sound macroeconomic policies to improve growth potential on a sustainable basis, export diversification, and continued efforts in fiscal consolidation. Moreover, increased utilization of donor grants and limiting recourse to concessional financing is necessary to maintain manageable public debt dynamics and reduce the risk of external debt distress. Sound public debt management, anchored in a medium-term debt management strategy (MTDS) and in line with the medium-term fiscal framework, is also essential to guide future development financing in Tonga. Priority should be given to projects, which would help generate high growth and employment to help ensure debt service capacity in the future.

Figure 2.
Figure 2.

Tonga: Indicators of Public Debt Under Alternative Scenarios, 2008–28 1/

Citation: IMF Staff Country Reports 2009, 292; 10.5089/9781451837513.002.A002

Sources: Country authorities; and Fund staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2018.2/ Revenues are defined inclusive of grants.
Table 1a.

External Debt Sustainability Framework, Baseline Scenario, 2005–2028 1/

(In percent of GDP, unless otherwise indicated)

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Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [r - g - r(1+g)]/(1+g+r+gr) times previous period debt ratio, with r = nominal interest rate; g =real GDP growth rate, and r = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 1b.

Tonga: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2008–2028

(In percent)

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Source: Staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in U. S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Table 2a.

Tonga: Public Sector Debt Sustainability Framework, Baseline Scenario, 2005–2028

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and Fund staff estimates and projections.

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.]

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Table 2b.

Tonga: Sensitivity Analysis for Key Indicators of Public Debt 2008–2028

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Sources: Country authorities; and Fund staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

1

This DSA was prepared jointly with the World Bank in accordance with the Debt Sustainability Framework for low-income countries approved by the Executive Boards of the IMF and IDA. The debt data underlying this exercise were provided by the Tongan authorities.

2

See “Debt Sustainability in Low-Income Countries: Proposal for an Operational Framework and Policy Implications” (http://www.imf.org/external/np/pdr/sustain/2004/020304.htm and IDA/SECM2004/0035, 2/3/04), “Debt Sustainability in Low-Income Countries: Further Considerations on an Operational Framework and Policy Implications” (http://www.imf.org/external/np/pdr/sustain/2004/091004.htm and IDA/SECM2004/0629, 9/10/04), and reference to “Staff Guidance Note on the Application of the Joint Bank-Fund Debt Sustainability.”

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Cover IMF Staff Country Reports
Tonga: 2009 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Tonga
Author: International Monetary Fund
Volume/Issue:
Volume 2009: Issue 292
Publisher:
International Monetary Fund
ISBN:
9781451837513
ISSN:
1934-7685
Pages:
68
DOI:
https://doi.org/10.5089/9781451837513.002
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    Tonga: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2008–2028 1/

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    Tonga: Indicators of Public Debt Under Alternative Scenarios, 2008–28 1/

Tonga: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2008–2028 1/

Tonga: Indicators of Public Debt Under Alternative Scenarios, 2008–28 1/