## 1tonea2021001 ## Source details **Canonical URL:** [1tonea2021001](https://www.imf.org/-/media/files/publications/cr/2021/english/1tonea2021001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1tonea2021001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1tonea2021001.pdf.json) --- ### Executive summary — recovery, outlook, and IMF support - Recovery interrupted by Cyclone Gita (2018), Cyclone Harold, and the pandemic. - FY2020 GDP growth estimated at -2½ percent. - Output projected to contract further to -3½ percent in FY2021 (FY begins July). - Borders early closure kept Tonga COVID-19-free; worst outcomes avoided. - Growth projected to gradually bounce back to 3−4 percent in FY2022−23 assuming travel and remittances normalize. - Long-term potential growth estimated at 1.8 percent, reflecting a remittance-dependent low-growth equilibrium. - IMF assistance requested under the Rapid Credit Facility (RCF): - Emergency assistance proposed: 6.9 million SDR (50 percent of IMF quota and 10 percent of external funding needs). - At SDR 6.9 million, around US$9.7 million (equivalent to 10 percent of the balance of payments funding need brought on by the pandemic). - If approved, RCF would increase IMF exposure to Tonga to 2 percent of GDP and 4 percent of gross international reserves in FY2021. - International reserves rose to US$251 million at end-October 2020 (about 9.7 months of import cover) due to import compression and fresh donor support. ### External balances, reserves, and external financing - FY2020 external position assessed broadly in line with fundamentals and desirable policy settings. - Recent reserve accumulation due to unspent aid and import compression is likely short-lived. - FY2021: expected large external financing gap from drops in tourism and remittances and higher pandemic- and reconstruction-related imports; reserves projected to fall sharply to well-below desirable levels (7¼ months of imports; Annex II). - Beyond FY2021: persistently weak export competitiveness, heavy import-dependence, and large infrastructure needs will keep current account deficits high. - Reserve coverage expected to trend down to around 4 months of imports as reconstruction picks up and large external debt repayments come due starting in 2024. - Short-term reserve options limited; include new external financing and enforcing repatriation requirements under the 2018 FEC Act. - Reserve adequacy (FY2020): - Actual reserves: US$241 million at end-FY2020 (about 9.6 months of imports). - Reserves increased to US$251 million by end-October 2020. - Optimal level taking into account debt repayment: 7.3 months of imports. - Recommendation: accumulate an additional US$91 million in reserves to finance rising debt repayments between FY2024−29 (implies US$21 million per year during FY2021−23 after accounting for already accumulated reserves of US$29 million in FY2020). ### Growth outlook, risks, and near-term outlook - Growth outlook fragile; downside risks include weaker global recovery, domestic COVID-19 outbreak, natural disasters, and CBR disruptions. - Authorities expect real output in FY2020 to contract by 2.5–2.7 percent; staff projections: FY2020 -2½ percent, FY2021 -3½ percent. - Upside risks: earlier resumption in SWPs or tourism or faster global recovery from vaccine success. - Long-term constraints: remoteness, high production costs, narrow production base, vulnerability to disasters (2018 Cyclone Gita caused devastation equal to 38 percent of GDP). - Remittances: Tonga is the world’s largest recipient; remittances support poverty reduction and liquidity but contribute to low-growth equilibrium by maintaining high reservation wages and reducing incentives for skill enhancement and private sector formation. ### Fiscal position, adjustment needs, and debt dynamics - FY2016–FY2020: five years of budget surpluses aided by donor grants; FY2021 budget balance will swing into a deficit due to weak economy, containment costs, and support measures. - Fiscal adjustment needed: 2½−3 percent of GDP achievable over FY2022−24 with new donor grants and capacity improvements. - Short-term FY2021 deficit financed by additional donor support, RCF resources, and suspension of FY2021 debt repayments to China Exim Bank. - Debt dynamics and vulnerabilities: - PV of public debt-to-GDP ratio expected to rise above the 70 percent debt-distress benchmark in FY2029 under current policies. - Risk of public and external debt-distress remains high. - Large external debt repayments come due starting in FY2024, especially to China Eximbank; amortization in FY2024 jumps to US$21.0 million. - Public debt at end-June 2020: 42 percent of GDP; PPG external debt: USD184 million (about 36 percent of GDP). - Largest external creditor: China Eximbank (58.4 percent of external PPG debt). - Fiscal policy recommendations: - Better targeted fiscal support. - Tax base broadening and removing exemptions (including CT exemption for the electricity company). - Stricter current spending controls and wage bill management. - Strengthen revenue administration, PFM, governance, and implementation capacity. - Prioritize health (including vaccines), infrastructure and maintenance. - Build social protection beyond elderly and disabled to enable scalable post-disaster assistance. - Maintain borrowing on concessional terms and aim to limit external debt-to-GDP ratio to below 50 percent where possible; institutionalize debt repayment resource management. ### Revenue measures and tax reform details - Transparency and public disclosure of tax exemptions needed. - Planned actions: - Review and closure of major CT exemptions. - Update excise tax rates, fees and charges (especially on property). - Broaden PIT base to include local employees of donors. - Close CIT loopholes for MNCs. - Collect tax arrears and reduce tax avoidance; improve collection of land-related fees. - Quantified revenue potential: - An additional 2½ percent of GDP in tax revenues could be collected by removing various tax exemptions, notably the CT exemption for the electricity company, and by improving processes. ### Monetary policy and financial sector priorities - Monetary policy stance: - Policy rate placed on hold at 0 percent. - Inflation reference rate at 5 percent. - Shelved pre-pandemic plans to raise the SRD rate. - Recommendation: continue monetary support, ensure adequate liquidity, lower SRD rate if liquidity pressures arise. - Banking system and NBFIs: - Four banks dominate; total assets 78 percent of GDP at end-June 2020. - NBFIs: 2 pension funds, 4 insurance companies, 12 foreign exchange dealers, 1 microfinance institution, several money lenders. - Asset quality and provisioning: - Reported NPL ratios range between 3−8 percent across banks; underlying NPL ratio could be above 10 percent. - Banks have deferred loan repayments on a case-by-case basis, ranging between 1-30 percent of their gross loan book. - NPLs could rise sharply in 2021 after debt relief measures expire. - Sensitivity: deterioration in NPLs to 25 percent could drive capital ratios below the regulatory threshold. - Profitability, capital, and liquidity: - Banks remain profitable and well-capitalized but face rising risks; profits declining due to project delays, market saturation, and stretched household debt-servicing capacity. - Banking system liquidity currently adequate; liquidity ratios declining as pension fund moved assets out of banking system. - Liquidity stress tests indicate holdings sufficient to meet assumed outflows across maturity buckets. - Supervision and regulatory actions: - Strengthen stress testing and adopt solvency stress testing framework with IMF TA. - Enhance NRBT’s risk assessment capacity and broaden credit information systems to cover NBFI lending. - Develop macroprudential instruments (e.g., Basel III countercyclical buffers, prudential limits on debt service-to-income). - Improve supervision of NBFIs; strengthen insurance and pension fund regulation via legislative changes. - AML/CFT and remittances: - Risk from loss of correspondent banking relationships (CBRs) and “de-risking” by international banks affecting remittance channels. - Amend AML/CFT framework to mandate a risk-based approach, improve enforcement, beneficial ownership transparency, and information sharing. - Authorities’ operational positions: - NRBT to maintain accommodative stance until recovery gains traction; may lower SRD rate if needed. - NRBT meets weekly with banks and plans improvements in credit bureau reporting and AML/CFT frameworks. ### Structural constraints and reform priorities - Main constraints: remoteness, high production costs, narrow production base, low economies of scale, high vulnerability to natural disasters. - Structural priorities: - Improve land market operations and modernize land lease process (e.g., remove Cabinet approval bottlenecks for leases above 5 years). - Strengthen female labor force participation and enable female property rights. - Increase business formation via climate-resilient investment, financial literacy, and lower credit costs. - Enact an insolvency law (politically sensitive) and deregulate protected sectors to allow greater foreign investment. - Promote TVET improvements and facilitate return/reintegration of SWP workers into higher value-added activities. - Consider NRBT-managed credit guarantee scheme with donor funding to incubate MSMEs. ### Climate resilience, disaster preparedness, and human capital - Priorities for climate resilience: - Implement high-quality strategic plans and transformational responses for long-term extreme events. - Build a public sector asset registry and enhance emergency management. - Improve human and financial capacity across government. - Spending needs and SDG implications: - IMF staff estimate additional annual spending to achieve five SDGs: about 7 percent of GDP in 2030. - Accounting for IMF staff estimates and authorities’ climate projects: total additional annual spending need about 13 percent of 2030 GDP in 2030. - Cost of climate-resilience projects (CCPA estimate): some 140 percent of 2018 GDP cumulatively; donor grant funding committed for about half. - Meeting selected SDG goals by 2030 will require additional annual spending of about 5 percent of 2030 GDP by 2030. - Policy recommendations: - Develop new national health, education, and strategic investment plans with clear priorities. - Strengthen PFM, spending efficiency, and domestic revenue mobilization. - Mobilize additional grant financing ("sine qua non") to avoid exacerbating debt levels. - Sequence implementation with capacity building. ### IMF RCF rationale, modalities, and safeguards - Staff supports authorities’ RCF request: access equivalent to 50 percent of quota (SDR 6.9 million). - RCF use: - Disbursement as budget support to finance Covid-19 response; anticipated credit to NRBT and on-lent to government. - Funds maintained in Treasury accounts at NRBT pending use. - Catalytic role: - RCF expected to catalyze additional IFI support. - Other donors have provided about US$17 million in grants since the outbreak; additional World Bank grants of some US$30 million under consideration for FY2021. - Safeguards: - NRBT committed to undertake a safeguards assessment and authorize external auditors to discuss with IMF staff and provide access to recent external audit reports. - Repayment capacity: - Tonga’s capacity to repay IMF assessed as adequate under current macro forecasts and policy commitments; major delays in commitments could pose risks. ### Debt sustainability analysis (DSA) — key findings and scenarios - Risk of external debt distress: High; overall risk of debt distress: High. - Public debt stock and trajectory: - Public debt 42 percent of GDP at end-June 2020; declined from 51 percent at end-June 2015 to 42 percent at end-June 2020. - Total public sector debt projected to rise to 49.1 percent of GDP in FY2024 and 57.3 percent in FY2025 (selected projections). - PV of public debt-to-GDP ratio expected to breach 70 percent benchmark in FY2029 under baseline. - Debt service pressures: - Large repayments to China Eximbank start in FY2024 (annual payments of about 2.5 percent of GDP in FY2024–29 on average). - Amortization between FY2020 and FY2023 averages around US$6.1 million per year; amortization in FY2024 jumps to US$21.0 million. - Stress tests: - Tailored natural disaster shock causes significant deterioration (e.g., one-off 14 percentage points to the debt-to-GDP ratio in a disaster year). - Combined shocks and export shocks have the largest negative impacts on external debt trajectories. - Policy implications: - Urgent need for fiscal adjustment, grant financing, debt relief, and measures to boost potential growth and resilience. - Improve debt coverage by reporting contingent debt and prepare a medium-term debt strategy prioritizing concessional/grant financing and refraining from non-concessional borrowing. ### Key quantitative indicators (selected, preserved exactly as in source) - SDR 6.9 million (50 percent of quota recommended RCF access). - Around US$9.7 million (equivalent of SDR 6.9 million). - Equivalent to 10 percent of Tonga’s balance of payments funding needs brought on by the pandemic. - Would increase IMF exposure to Tonga to 2 percent of GDP and 4 percent of gross international reserves in FY2021. - Other donors have provided about US$17 million in grants since the outbreak of the pandemic. - Additional World Bank grants of some US$30 million is being considered for FY2021. - FY2020 GDP expected change: -2½ percent. - FY2021 GDP expected change: -3½ percent. - Reserve coverage expected to decline to around 4 months of imports by 2025 (desirable level: 7¼ months of imports). - Fiscal adjustment path suggested: 2½−3 percent of GDP on average over FY2022−24. - Real GDP (Est.) series: FY2018 0.3; FY2019 0.7; FY2020 -2.5; FY2021 -3.5; FY2022 4.0; FY2023 3.0. - Consumer prices (period average) series: FY2018 6.8; FY2019 3.3; FY2020 0.2; FY2021 -0.9; FY2022 2.1; FY2023 2.0. - Gross official foreign reserves (millions USD) series: FY2018 214.9; FY2019 212.8; FY2020 241.9; FY2021 192.3; FY2022 169.1; FY2023 147.7. - Reserves (In months of next year's total imports) series: FY2018 7.8; FY2019 8.2; FY2020 9.6; FY2021 6.7; FY2022 5.5; FY2023 4.7. - Total assets of banks: 78 percent of GDP at end-June 2020. - Reported NPL ratios range between 3−8 percent across banks. - Banks have deferred loan repayments ranging between 1-30 percent of their gross loan book. - Banking system public debt (end-June 2020): Public domestic debt USD31 million (about 6 percent of GDP), accounting for 15 percent of total public debt. - Outstanding IMF credit (Millions of SDRs) series: FY2020 0.0; FY2021 6.9; FY2022 6.9; FY2023 6.9; FY2024 6.9; FY2025 6.9; FY2026 6.9; FY2027 6.9; FY2028 6.9; FY2029 6.9; FY2030 6.9; FY2031 6.9; FY2032 6.9; FY2033 6.9. - Current account balance (Est., millions USD) series: FY2018 -30.7; FY2019 -4.4; FY2020 -19.6; FY2021 -85.9; FY2022 -50.5; FY2023 -46.9. - Remittances (Est., millions USD) series: FY2018 137.1; FY2019 141.6; FY2020 144.9; FY2021 113.8; FY2022 122.4; FY2023 128.0. - Remittances (Memorandum, percent of GDP) series: FY2018 28.2; FY2019 27.4; FY2020 28.7; FY2021 23.2; FY2022 23.3; FY2023 23.2. - Fiscal projections (selected): Total Revenue (percent of GDP) FY2024 34.6; FY2025 32.3. Total Expenditure (percent of GDP) FY2024 42.7; FY2025 42.3. Overall Balance (percent of GDP) FY2024 -8.1; FY2025 -10.0. - External financing requirements (Total requirement, millions USD): FY2019 10.3; FY2020 24.4; FY2021 123.1; FY2022 57.8; FY2023 56.1; FY2024 89.0; FY2025 91.1. - Financing gap (selected): FY2019 2.1; FY2020 -29.1; FY2021 94.7; FY2022 23.2; FY2023 21.4; FY2024 -1.5; FY2025 -0.7. *Source: IMF staff report (content unit 1tonea2021001).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Recovery Interrupted and Near-Term Outlook - Tonga’s recovery from the 2018 Cyclone Gita was derailed by the pandemic and Cyclone Harold. - FY2020 GDP growth is estimated to fall to -2½ percent. - The full brunt of the pandemic is expected in FY2021 (beginning July) during peak tourism season, with output projected to contract further to -3½ percent in FY2021. - A worse outcome was avoided by early closure of external borders, which has kept Tonga COVID-19-free. - Beyond FY2021, recovery is expected to resume in line with the global recovery, with growth projected to gradually bounce back to 3−4 percent in FY2022−23, assuming travel and remittances normalize. - Over the longer-term, potential growth is estimated at 1.8 percent, reflecting a remittance-dependent low-growth equilibrium. ### IMF Financial Assistance and Balance of Payments Needs - Given limited fiscal buffers and urgent balance of payments needs, Tonga requested IMF financial assistance under the Rapid Credit Facility (RCF). - Emergency assistance of 6.9 million SDR is proposed (50 percent of IMF quota and 10 percent of external funding needs). - The emergency assistance, together with funding from other international partners, would help Tonga weather the shock while borders remain closed and leave room for further borrowing should another natural disaster occur. - International reserves rose to US$251 million at end-October 2020 (about 9.7 months of import cover) due to import compression and fresh donor support. ### Fiscal Position and Medium-Term Adjustment - After five years of budget surpluses helped by donor grants, the FY2021 budget balance will swing into a deficit due to a weak economy, containment costs, and support measures. - A fiscal adjustment of 2½−3 percent of GDP is needed and could be achievable over FY2022−24 once the pandemic is over. - Suggested measures to achieve adjustment include: - Better targeted fiscal support. - Tax base broadening. - Stricter current spending controls. - Strengthened capacity and continued improvements in revenue collection, governance, and public financial management. - Spending priorities: health (including vaccines), infrastructure and maintenance. - More donor grants and debt relief could accelerate policy goals, provided implementation capacity is improved. ### Monetary and Financial Sector Policy Priorities - Monetary policy support should continue; monetary policy was placed on hold with policy rate at 0 percent. - Though banks are still profitable and well-capitalized, financial sector risks are rising and additional provisioning and a capital boost may be required in some banks. - Priority actions: - Strengthen stress testing. - Monitor household debt. - Establish a macroprudential framework. - Improve supervision of nonbank financial intermediaries. - Strengthen regulations (insolvency and insurance). - Enhance the AML/CFT framework and enforcement. ### Structural Constraints and Reform Priorities to Raise Growth - Tonga’s growth potential has long been constrained by remoteness, high production costs, a narrow production base, low economies of scale, and high vulnerability to natural disasters (2018 Cyclone Gita caused devastation equal to 38 percent of GDP). - The growth model is heavily reliant on labor exports and remittances, making Tonga the world’s largest recipient of remittances. - Remittances have supported poverty reduction and financial sector liquidity but have contributed to a low-growth equilibrium by: - Maintaining high reservation wages relative to remitting countries. - Reducing incentives to enhance skills and enter the workforce. - Constraining private sector formation and diversification. - Main structural priorities to grow the private sector: - Improve land market operations. - Strengthen female labor force participation. - Increase business formation by investing in climate-resilience. - Enact an insolvency law. - Deregulate investments. - Strengthen financial literacy while lowering credit costs. ### Risks and Uncertainties - The medium-term outlook is fragile with downside risks from: - A weaker global recovery that tempers exports, aid, and remittances. - A local COVID-19 outbreak. - High vulnerability to natural disasters and a high risk of external debt distress. - Weak competitiveness, high import-dependence, and large impending debt repayments, which are likely to reduce international reserves below desirable levels in the medium-term. *Source: EXECUTIVE SUMMARY, 1tonea2021001* ### 9. External balances are expected to deteriorate. Tonga’s external position in FY2020 is ### 1tonea2021001 - 9. External balances are expected to deteriorate. Tonga’s external position in FY2020 is ### External balances, reserves, and external financing - Tonga’s external position in FY2020 is assessed to be broadly in line with fundamentals and desirable policy settings (Annex II). - Recent reserve accumulation due to unspent aid and import compression is likely to be short-lived. - A drop in tourism and remittance inflows, and higher imports related to COVID-19 (e.g., medical supplies) and post-Harold private sector reconstruction, are expected to generate a large external financing gap (Table 8) and sharply reduce reserves in FY2021 to well-below its desirable levels (7¼ months of imports; Annex II). - Beyond FY2021, persistently weak export competitiveness, heavy import-dependence, and large infrastructure needs will keep current account deficits high. - As reconstruction picks up and large external debt repayments come due starting in 2024, reserve coverage is expected to trend down to around 4 months of imports, well below desirable coverage levels. - Short-term policy options to bolster reserves are limited due to capacity constraints, high import-dependence, weak monetary transmission, and the need for continued government support to lean against the pandemic; options include new external financing and enforcing repatriation requirements allowed under the 2018 Foreign Exchange Control (FEC) Act. - Measures to improve export competitiveness and reduce import-reliance can provide a more lasting solution but will take time to implement. ### Growth outlook, risks, and near-term outlook - The growth outlook is fragile (Annex III). - Downside risks include a weaker global recovery due to a second wave of the pandemic and rising forces of deglobalization that may temper exports, aid and remittances. - A possible domestic spread of COVID-19 is a major downside risk given the economy’s heavy reliance on domestic demand. - The pandemic has worsened pre-existing vulnerabilities: Tonga’s risk of external debt distress remains high; another major cyclone could worsen the contraction; and vulnerability to disruptions in CBRs could threaten remittance channels. - If shortcomings identified in the upcoming APG assessment are not addressed, international banks could withdraw from servicing remitters, negatively impacting GDP and financial stability. - Upside risks include an earlier-than-anticipated resumption in SWPs or tourism or a faster global recovery due to an early vaccine success. - Authorities expect real output in FY2020 to contract by 2.5–2.7 percent. A further contraction is expected in FY2021 (-3.7–3.9 percent) due to border closures and low consumer confidence despite some reallocation of service sector workers. - Authorities intend to keep external borders closed for the foreseeable future and prioritize preventing a local COVID-19 outbreak; they share staff concerns about external sustainability and the need to maintain higher levels of reserves given Tonga’s vulnerability and large external debt. ### Fiscal position, buffers, and debt dynamics - Despite a string of budget surpluses through FY2020, fiscal challenges remain daunting. - The FY2019–20 surpluses reflect continued strength in revenue collection and controls on current spending, aided by donor support. - Additional pandemic- and cyclone-related spending was financed with new donor funds, domestic debt issuance, spending reallocations, and a temporary drawdown of emergency and reserve funds. - Underlying policy weaknesses include investment delays and pre-pandemic healthcare and wage bill overruns compensated by lower maintenance spending. - Main fiscal challenges going forward: - The risk of public and external debt-distress remains high and debt repayments are set to spike starting in FY2024, especially to China EXIM Bank (Figure and DSA). - The PV of public debt-to-GDP ratio is expected to rise above the 70 percent debt-distress benchmark in FY2029 under current policies and financing commitments. - Without significant fiscal adjustment and new grant financing, low fiscal buffers (1-2 months of current spending at end-FY2020) and international reserves would be run down and additional debt incurred, leading to an exploding medium-term debt path. - The cost of achieving climate-resilience and development goals is formidable: the CCPA estimated climate-resilience projects will cost some 140 percent of 2018 GDP cumulatively, of which donor grant funding has been committed for about half. - Meeting selected SDG goals by 2030 will require an additional annual spending of about 5 percent of 2030 GDP by 2030 (Annex IV). - A small tax base and limited public sector capacity hinder large-scale, front-loaded consolidation. - Given weak monetary transmission and an exchange rate peg, fiscal policy is the primary tool to support the economy during the pandemic; the surplus planned in the draft FY2021 budget strategy has been shelved. - The FY2021 budget balance is likely to swing into a deficit. The deficit will be financed by additional donor support, resources disbursed under the Rapid Credit Facility (RCF), and a suspension of FY2021 debt repayments to China Exim Bank. - Tonga’s request for a suspension of 2020 debt repayments to China Exim Bank under the G20 DSSI has been approved; authorities intend to request suspension of repayments due in the first half of 2021. ### Fiscal adjustment, reform priorities, and debt sustainability measures - Post-pandemic, better-quality surpluses are needed to achieve debt sustainability while meeting climate and development goals without relying on external budget grants exceeding historical trends. - Without new grant commitments, a major fiscal consolidation would be required; such consolidation is infeasible and undesirable given capacity constraints and climate/development needs. - With new donor grants, fiscal adjustment of 2½−3 percent of GDP relative to baseline forecasts—ideally front-loaded—could be achievable over FY2022−24. With the right policies, the economic impact can be minimized given low fiscal multipliers. - There is scope to improve targeting of exemptions and broaden the tax base: - Greater transparency and public disclosure of the criteria, time frame, recipients, and amounts of tax exemptions are needed. - The planned review and closure of major CT exemptions; updated excise tax rates, fees and charges, especially on property; and further improvements in revenue administration through training and better risk assessment, are steps in the right direction. - An additional 2½ percent of GDP in tax revenues could be collected by removing various other tax exemptions, notably the CT exemption for the electricity company, and by improving processes (Liu and Mullins, 2020). - Tax breaks for the electricity company should be removed and the full cost of diesel passed on to consumers to help achieve Tonga's emission targets; any rise in electricity tariffs could be phased in while protecting vulnerable households. - Additional measures could include: further reducing excise and CT exemptions; broadening the PIT base to include local employees of donors; closing CIT loopholes for MNCs; collecting tax arrears and reducing tax avoidance; and improving collection of land-related fees. - Tax policy design should reside in the MOF; reinstating the Revenue Policy Committee could drive tax policy reform. - Spending policies should focus on efficiency, capacity, and value-for-money: - FY2022 budget should evaluate and rectify slippages vis-à-vis fiscal anchors and later review fiscal anchors with IMF assistance. - Near-term priority: ensure priority spending (basic healthcare system and infrastructure maintenance) is not crowded out by pandemic measures. - Build out the social protection system (beyond the elderly and disabled) to allow scalable assistance after disasters and during pandemics and to enable targeted utility bill assistance while reducing CT exemptions for the electricity company. - Planned health insurance system and voluntary retirement scheme should be properly designed to avoid unintended consequences. - Continue centralizing and strengthening hiring and staffing decisions; rationalize civil service functions; clarify job descriptions; identify and staff critical positions; increase automation; phase out redundant positions; prioritize service delivery; gradually align compensation with market pay while eliminating overtime; and strengthen controls on allowances and non-permanent staff costs. - Improve implementation through consistent prioritization, better sequencing, cross-government coordination, and stronger project prioritization and publication to allow private markets to prepare. - Debt management should be improved: - Maintain policy of borrowing only on concessional terms and limiting external debt-to-GDP ratio to below 50 percent where possible. - Ideally restrict financing to grants for debt sustainability. - Adopt a medium-term debt strategy with documentation of policies and procedures guiding borrowing and guarantees. - Consider expanding domestic borrowing through financial deepening in the medium-term to limit reliance on external financing and improve monetary transmission. - Institutionalize management of resources set aside for debt repayments via legislation. ### Donor coordination, transparency, and accountability - Donor support remains considerable and will continue to be needed; assistance could be better aligned with government priorities, more coordinated, more inclusive, and use (while strengthening) Tonga's PFM and information systems. - Further enhancements in transparency and accountability of government operations could strengthen the case for more donor support and debt relief: - Finalize the public financial action plan, strengthen cash management and financial management information systems, and internal audit processes to improve monitoring. - Pandemic-related spending and relief packages should be transparent, closely monitored, audited, and reported in a timely manner. - Publication of audited COVID-19 related spending and pandemic-related public procurement documents (including beneficial owners of companies awarded contracts) would be desirable. *International Monetary Fund staff summary based on the source content.* ### 22. The authorities’ assessment of fiscal challenges were in sync with those of staff. Noting ### 1tonea2021001 - 22. The authorities’ assessment of fiscal challenges were in sync with those of staff. Noting ### Fiscal assessment and policy priorities - Authorities and staff agree Tonga faces a risk of high public and external debt distress. - Authorities welcomed the G20 Debt Service Suspension Initiative and hoped it would be extended to ensure further reductions in debt burdens. - Financing priorities and options: - Seek new grant financing from donor partners as a first priority. - Bilaterally pursue additional debt relief from China Exim Bank. - Concessional loans from the IMF may be needed, including additional funding under the RCF in the event of a major natural disaster giving rise to urgent balance of payments needs. - Implementation and transparency commitments: - Accelerate implementation of investments to make full use of disbursed financial assistance. - Audited pandemic-related spending and all procurement documents will be published, including owners of awarded companies; efforts to identify and publish beneficial owners will be made once appropriate disclosure modalities are established. - Fiscal policy reforms to meet goals and debt repayments: - Tax base broadening. - Prioritization of targeted support, health and infrastructure spending. - Stricter wage bill controls. - Improved processes, governance, public financial management and implementation capacity. - Extend social protection; ensure greater transparency and accountability in the provision of tax exemptions. - Implementation timeline and related strategies: - Recommendations by the ADB, IMF and World Bank reviews will be implemented starting in FY2022. - New climate and medium-term debt strategies are being developed. - Revenue administration actions: - Improve tax compliance of high-value taxpayers through audit, debt recovery and stronger risk assessments. ### Monetary policy stance and liquidity - The NRBT maintained an accommodative monetary policy stance given low inflation and economic contraction. - Policy settings and actions: - Monetary policy rate at 0 percent. - Inflation reference rate at 5 percent. - Shelved pre-pandemic plans to raise the statutory reserve deposit (SRD) rate. - Closely monitoring liquidity conditions; signaled willingness to ease liquidity and exchange control requirements if necessary. - Reviewed currency basket-weights in 2020 to maintain exchange rate stability. - Pension fund and foreign exchange measures: - Allowed the public sector pension fund to transfer balances abroad pre-COVID with understanding they might need repatriation in times of external stress. - Given significant build-up in international reserves, NRBT has not needed to invoke the provisions of the 2018 FEC Act. - Expected repeal of the Foreign Exchange Levy in June 2020 is no longer under consideration and the public sector pension fund has opted to halt overseas investments. - Policy guidance: - Monetary policy should stay supportive and ensure adequate liquidity; lower the SRD rate if liquidity pressures arise. - In extreme stress, consider restricting resident investments abroad or seeking repatriation of pension fund investments abroad provided repatriation does not incur large losses. - Continue to look through temporary inflation spikes from domestic supply-side and global commodity price shocks. ### Financial sector risks, performance, and supervision - Banking system structure and size: - Tonga’s financial landscape is dominated by four banks (three foreign-owned bank subsidiaries and a government development bank), with total assets of 78 percent of GDP at end-June 2020. - NBFIs include 2 pension funds, 4 insurance companies, 12 foreign exchange dealers, 1 microfinance institution, and several money lenders. - Asset quality and NPLs: - Reported NPL ratios range between 3−8 percent across banks. - NPLs ticked up recently due to agricultural losses and non-performing housing loans. - Banks have deferred loan repayments on a case-by-case basis, ranging between 1-30 percent of their gross loan book. - Only one bank has raised provisions significantly with a forward-looking approach, signaling underlying NPL ratio could be above 10 percent. - NPLs could rise sharply in 2021 for some banks after debt relief measures expire and if loan reclassification is needed. - Profitability and capital adequacy: - Banks remain profitable and well-capitalized but do not yet reflect possible deterioration in asset quality. - Capital buffers could come under pressure as profits decline from emerging loan defaults and lower operating income. - Sensitivity analysis suggests that a deterioration in NPLs to 25 percent could drive capital ratios below the regulatory threshold. - Options to raise bank capital: retaining earnings (if still positive) and capital injections from shareholders; parent bank injections would be warranted if capital buffers come under stress. - Bank profits were declining even before the pandemic due to delays and cancellations of projects, market saturation, and stretched household debt-servicing capacity. - Liquidity: - Banking system liquidity currently adequate due to rising deposits, onshore profits retention, and remittance inflows. - Liquidity ratios have been on a declining trend as the pension fund moved part of its assets out of the banking system. - A sharp decline in remittances or deposit drawdowns could generate liquidity pressures, including in foreign currency. - Liquidity stress tests indicate holdings are sufficient to meet assumed outflows across different maturity buckets for individual banks and the system. - Supervision and regulatory priorities: - Ongoing improvements in financial supervision should be accelerated; NRBT is strengthening risk-based offsite supervision. - Near-term priorities: - Enhance NRBT’s risk assessment capacity and take preemptive steps to ensure adequate provisioning and capitalization. - Establish a solvency stress testing framework with IMF TA. - Enhance household debt monitoring by broadening credit information systems to cover NBFI lending. - Develop macroprudential instruments, e.g., Basel III countercyclical capital buffers and prudential limits on debt service-to-income. - NRBT capacity to supervise NBFIs is lagging the expansion of their activities. - AML/CFT vulnerabilities and remittances: - Tongan money operators have seen bank accounts closed due to “de-risking” by international banks. - Loss of correspondent banking relationships (CBRs) could magnify the cost of, and reduce, remittance inflows—significant for macrofinancial stability. - To reduce vulnerability, amend AML/CFT framework to mandate a risk-based approach, strengthen regulations, and improve enforcement through increased awareness, adequate resources, and better information sharing—particularly on beneficial ownership and politically exposed persons. - Authorities’ views on supervision and reforms: - NRBT plans to maintain an accommodative monetary stance until recovery gains traction and improve monetary transmission via liquidity management and communication. - NRBT considers lowering the SRD rate if additional liquidity needs arise. - NRBT assessed the banking system as sound but agreed that risks have increased and enhanced vigilance is needed. - NRBT meets weekly with banks to ensure preparedness and best prudential practices. - Improvements to stress testing framework with IMF technical assistance would be desirable. - Efforts underway to improve credit bureau reporting requirements; legislative changes are needed for licensing and supervision of insurance companies, pension funds, and capital markets. - NRBT plans to improve financial literacy and awareness once regulations are finalized and is undertaking a gap analysis to strengthen AML/CFT frameworks in consultation with the Attorney General. ### Structural reforms to unlock private sector potential - Rationale: - A stronger business climate and private sector would help broaden the tax base, increase fiscal resilience, expand the financial sector and its capacity to hold government debt, and enable Tonga to gain from Pacer Plus by attracting investments to increase exports and climate resilience. - Constraints and reform priorities: - Tonga performs well on many business environment aspects but lags in registering property, protecting minority investors, and insolvency legal framework and processes. - Scope to improve governance: regulatory quality and enforcement, government effectiveness, and control of corruption. - Potential gains relative to a “business-as-usual” scenario include substantial additional economic growth, revenues, and job creation via reforms in tourism, labor market skilling, and ICT. - Land market reforms: - Complexity and delays in leasehold operations pose major hurdles—e.g., all leases above 5 years require Cabinet approval. - Short lease tenures, uncertainties about renewal and property rights, and unclear creditor rights constrain investment and banks' ability to support long-term projects. - Modernizing and clarifying the land lease process—improve transparency and predictability on lease tenures, renewal, and ownership rights—could maximize use of vacant or underutilized land, improve investment, and strengthen incentives for climate-resilient structures. - Female labor force participation: - Stronger female labor force participation would lift productivity; female workforce has more years of schooling and lower likelihood of emigration. - Women are constrained by land ownership limits, inadequate legal protection of property rights, and poor representation in Government. - Plans to improve female participation are ill-defined and under-resourced. - A landmark Employment Relations Bill, approved by Cabinet in 2019, could potentially improve employment conditions for women once enacted. *Source: 1tonea2021001 - 22. The authorities’ assessment of fiscal challenges were in sync with those of staff. Noting* ### 35. Improving climate resilience is of utmost importance. ### 35. Improving climate resilience is of utmost importance. ### Priorities for climate resilience and disaster preparedness - Main priorities: - Consistently implement high-quality strategic plans. - Gear up for “transformational” responses for long-term extreme events (such as sea level rises). - Improve risk management by building a proper public sector asset registry. - Continue to enhance emergency management. - Improve human and financial capacity across the board. ### Labor and human capital - Improving the supply of skilled labor is vital: - Build and maintain safe schools. - Improve the quality, relevance, and access to TVET programs and secondary and tertiary education. - Donors could support efforts by ensuring SWPs help boost skills relevant to Tonga's circumstances and complement them with mechanisms to facilitate return and reintegration of workers into higher value-added economic activities. ### Private sector development, business formation, and land administration - Measures to increase business formation and credit to MSMEs: - Improve the insolvency regime to provide banks and private companies with a predictable and transparent resolution framework. - Greater competition in corporate lending by further developing NBFIs. - Land leasehold reforms to facilitate the use of real estate as collateral. - Enhanced financial training and literacy for MSMEs (accounting, budgeting) to reduce screening and lending costs. - Deregulate restricted lists of protected sectors to allow greater foreign investment. - Legal and administrative reforms under consideration: - Amendments to the 2018 FEC Act are being considered to ensure protection of international reserves while providing certainty for investors and the public. - Amendments repealing provisions related to immovable property in or outside Tonga are under consideration. - A draft land reform bill introduced in Parliament awaits consideration. - The Land Ministry is working to digitalize records and create an online portal to improve transparency and administration of leasing. - An insolvency law would be politically untenable as it is closely tied to the land tenure system. - Enabling female property rights and strengthening female labor force participation are acknowledged as needed but complicated. ### Authorities’ views on private sector and labor policies - Developing the private sector is an important strategic priority. - The NRBT is considering managing a credit guarantee scheme (similar to that of Fiji) with donor funding to incubate small businesses with funding and training. - Authorities support seasonal worker programs (SWPs) as they boost remittances in the short term, while acknowledging the dampening effect of labor exports on growth potential. - Authorities support mechanisms to facilitate the return and reintegration of workers into higher value-added economic activities. ### IMF financing needs and role of RCF support - Rationale for IMF assistance: - IMF assistance through the RCF is needed to meet Tonga’s urgent balance of payment needs due to the pandemic and Cyclone Harold. - The terms of the RCF make it the most suitable IMF concessional financing facility for Tonga. - Recommended access and amounts: - Staff supports the authorities’ request for financial assistance under the RCF equivalent to 50 percent of quota (SDR 6.9 million). - At 6.9 million SDR, around US$9.7 million, the amount to be provided under the RCF would be equivalent to 10 percent of the balance of payments funding need brought on by the pandemic. - Access of 50 percent of quota under the exogenous shock window of the RCF would be appropriate. - If approved, the proposed RCF would increase the IMF’s exposure to Tonga to 2 percent of GDP and 4 percent of gross international reserves in FY2021. - Use and modalities: - The RCF disbursement will be made available as budget support to finance the authorities’ response to the Covid-19 pandemic. - It is anticipated that the RCF allocation would take the form of a credit to the NRBT, subsequently on-lent to the government. - The Ministry of Finance and NRBT are finalizing a Memorandum of Understanding on respective roles and responsibilities for servicing financial obligations to the IMF. - Funds will be maintained in the Treasury accounts at the NRBT pending their use. - Catalytic and complementary financing: - Budget support through the proposed RCF is expected to catalyze additional support from IFIs. - Other major donors have already provided about US$17 million in grants as new budget support since the outbreak of the pandemic. - Additional World Bank grants of some US$30 million is being considered for FY2021. - Repayment capacity and risks: - Tonga’s capacity to repay the IMF is adequate. - The proposed disbursement would increase IMF exposure to some 2 percent of GDP and 4 percent of gross international reserves in FY2021. - Tonga remains at high risk of debt distress, but debt is assessed to be sustainable under current macroeconomic forecasts given the authorities' policy commitments to undertake fiscal adjustment and seek new donor support including debt relief. - Major delays in honoring these commitments could pose risks to debt sustainability. - Safeguards: - The NRBT has committed to undertake a safeguards assessment in connection with the RCF and to authorize external auditors to hold discussions with IMF staff and provide access to recent external audit reports. ### Macroeconomic outlook, vulnerabilities, and staff appraisal - Growth and output: - FY2020 GDP is expected to have dropped by -2½ percent due to domestic containment measures, economic uncertainty, a halt in SWPs and tourism, and investment delays. - Output is expected to contract further by -3½ percent in FY2021 as Tonga’s peak tourism season gets underway while borders remain closed, and reconstruction delays continue. - Assuming borders reopen by end-FY2021, a gradual recovery could be expected in FY2022−23, but this remains uncertain. - External balances and reserves: - Declines in tourism and remittances and higher pandemic- and reconstruction-related imports are expected to generate a large external financing gap, sharply reducing reserves in FY2021 from current record highs. - Reserve coverage is expected to decline to around 4 months of imports by 2025, well below desirable levels (7¼ months of imports). - Beyond FY2021, large external debt repayments starting in 2024 imply current account deficits are likely to remain large. - Fiscal policy and debt dynamics: - A fiscal deficit is unavoidable in FY2021 to support the economy, but priority spending on healthcare (including vaccines), maintenance, and investment should be protected. - Aided by donor support in the form of new grant commitments and/or debt relief, fiscal adjustment of 2½−3 percent of GDP could be achievable on average over FY2022−24. - The tax base should be broadened by gradually closing major CT exemptions, updating excise tax rates, fees and charges, closing tax loopholes, collecting tax arrears and reducing tax avoidance, and improving the collection of land-related fees. - Stricter current spending controls are warranted within the current fiscal anchors to improve efficiency, capacity and value for money. - Financial sector and supervision: - Banks are still profitable and well capitalized, but financial sector risks are elevated. - The NRBT’s risk assessment capacity should be enhanced; preemptive steps needed to ensure banks are adequately provisioned and capitalized. - A solvency stress testing framework needs to be established. - Household debt monitoring should be enhanced by broadening credit information systems to cover lending by NBFIs. - Macroprudential instruments should be developed to limit systemic risk. - Given the importance of remittances, the AML/CFT framework should be strengthened as a matter of priority. - Structural reform priorities to boost long-term resilience and growth: - Grow the small private sector to broaden the tax base and boost financial sector growth. - Modernize and clarify the land lease process by improving transparency and predictability on lease tenures, renewal and ownership rights. - Increase female labor force participation. - Improve the supply of skilled labor, including through improved TVET programs and mechanisms to facilitate the return and reintegration of SWPs into higher value-added economic activities. - Improve regulations (such as the 2018 FEC Act and insolvency laws), deregulate protected sectors, and boost official capacity. - Improve the quality, timeliness and dissemination of statistics. - External risks and outlook: - The medium-term outlook is modest and fragile; Tonga’s growth potential is low. - Downside risks include a weaker global recovery, local outbreaks, and disruptions in correspondent banking relations. - Financial sector risks are elevated, and the risk of public and external debt distress is high. - Monetary policy recommendation: - Monetary policy support should continue, given low inflation. - The NRBT should continue to ensure adequate liquidity levels and lower the SRD rate should liquidity pressures arise. ### Key statistics and figures - SDR 6.9 million (50 percent of quota recommended RCF access). - Around US$9.7 million (equivalent of SDR 6.9 million). - Equivalent to 10 percent of Tonga’s balance of payments funding needs brought on by the pandemic. - Would increase IMF exposure to Tonga to 2 percent of GDP and 4 percent of gross international reserves in FY2021. - Other donors have provided about US$17 million in grants since the outbreak of the pandemic. - Additional World Bank grants of some US$30 million is being considered for FY2021. - FY2020 GDP expected change: -2½ percent. - FY2021 GDP expected change: -3½ percent. - Reserve coverage expected to decline to around 4 months of imports by 2025 (desirable level: 7¼ months of imports). - Fiscal adjustment path suggested: 2½−3 percent of GDP on average over FY2022−24. - Large external debt repayments come due starting in 2024. *Source: IMF staff report (content unit 1tonea2021001 - 35).* ### 57. It is recommended that, instead of the current biannual cycle, the next Article IV ### 1tonea2021001 - 57. It is recommended that, instead of the current biannual cycle, the next Article IV Consultation for Tonga take place on a standard 12-month cycle. ### Recommendation - It is recommended that, instead of the current biannual cycle, the next Article IV Consultation for Tonga take place on a standard 12-month cycle. ### Macroeconomic outlook and pandemic impact - Net exports contracted due to the pandemic; the services sector was hit particularly hard. - Growth and inflation: - Real GDP (Est.): FY2018 0.3; FY2019 0.7; FY2020 -2.5; FY2021 -3.5; FY2022 4.0; FY2023 3.0. - Consumer prices (period average): FY2018 6.8; FY2019 3.3; FY2020 0.2; FY2021 -0.9; FY2022 2.1; FY2023 2.0. - Consumer prices (end of period): FY2018 6.7; FY2019 -0.1; FY2020 -1.4; FY2021 1.8; FY2022 2.4; FY2023 1.6. - GDP deflator: FY2018 5.1; FY2019 7.7; FY2020 0.4; FY2021 -0.9; FY2022 2.1; FY2023 2.0. - Growth comparison: - Growth is expected to be higher than regional peers, but inflation has been much lower. - Inflation remains well below the NRBT’s reference rate, falling into negative territory since June 2020, helped by low global commodity and food prices and lower domestic food prices. ### External sector and reserves - Current account and trade: - Current account balance (Est., millions USD): FY2018 -30.7; FY2019 -4.4; FY2020 -19.6; FY2021 -85.9; FY2022 -50.5; FY2023 -46.9. - Current account (In percent of GDP): FY2018 -6.3; FY2019 -0.9; FY2020 -3.9; FY2021 -17.5; FY2022 -9.6; FY2023 -8.5. - Trade balance (In percent of GDP): FY2018 -41.4; FY2019 -40.1; FY2020 -38.8; FY2021 -39.5; FY2022 -41.2; FY2023 -41.3. - Exports, f.o.b. (Est., millions USD): FY2018 14.2; FY2019 15.8; FY2020 18.3; FY2021 14.4; FY2022 17.7; FY2023 19.0. - Imports, f.o.b. (Est., millions USD): FY2018 215.3; FY2019 223.3; FY2020 213.7; FY2021 208.2; FY2022 234.6; FY2023 246.7. - Transfers and remittances: - Transfers balance (Est., millions USD): FY2018 158.9; FY2019 172.4; FY2020 154.4; FY2021 181.3; FY2022 168.7; FY2023 182.6. - Remittances (Est., millions USD): FY2018 137.1; FY2019 141.6; FY2020 144.9; FY2021 113.8; FY2022 122.4; FY2023 128.0. - Remittances (Memorandum, percent of GDP): FY2018 28.2; FY2019 27.4; FY2020 28.7; FY2021 23.2; FY2022 23.3; FY2023 23.2. - Reserves: - Gross official foreign reserves (millions USD): FY2018 214.9; FY2019 212.8; FY2020 241.9; FY2021 192.3; FY2022 169.1; FY2023 147.7. - Reserves (In months of next year's total imports): FY2018 7.8; FY2019 8.2; FY2020 9.6; FY2021 6.7; FY2022 5.5; FY2023 4.7. - External shock mitigation: - The external shock was mitigated by import compression and aid. - A modest pickup in remittances offset a sharp decline in travel receipts. - Low inflation contributed to a small REER depreciation which boosted competitiveness. - Reserves are at all-time highs due to higher capital transfers (grants) and import compression. ### Monetary conditions and banking sector - Monetary policy and liquidity: - Monetary policy remains on hold; liquidity levels remain adequate. - Total liquidity (M3, percent change): FY2018 7.6; FY2019 4.3; FY2020 1.2; FY2021 -8.9; FY2022 10.6; FY2023 7.7. - Broad money (M2, percent change): FY2018 9.4; FY2019 3.5; FY2020 1.1; FY2021 -9.4; FY2022 11.1; FY2023 8.0. - Domestic credit (percent change): FY2018 -6.5; FY2019 6.0; FY2020 -15.7; FY2021 4.0; FY2022 18.4; FY2023 12.0. - Private sector credit (percent change): FY2018 6.7; FY2019 7.6; FY2020 1.1; FY2021 0.7; FY2022 3.4; FY2023 3.9. - Banking sector performance and risks: - Capital buffers remain above the PIC average. - Bank profitability continues to rely on large NIMs and wide interest rate spreads. - Profitability has been declining due to slower credit growth; NPLs have started to tick up. - Bank lending remains concentrated in residential loans. - Financial inclusion: improving financial inclusion stalled during the pandemic; lower bank profits delayed new bank branches, new ATMs, EFTPOS, and cash points. Mobile money transactions have been rising. ### Fiscal position and public debt - Fiscal balances and revenues: - Fiscal balances have been in surplus since FY2016; a fifth consecutive budget surplus was recorded in recent years. - Total Revenue (In percent of GDP): FY2018 42.6; FY2019 41.7; FY2020 45.7; FY2021 45.7; FY2022 42.0; FY2023 44.4. - Revenue (excluding grants, percent of GDP): FY2018 24.8; FY2019 23.4; FY2020 24.7; FY2021 22.9; FY2022 23.9; FY2023 24.3. - Grants (percent of GDP): FY2018 17.8; FY2019 18.3; FY2020 21.0; FY2021 22.9; FY2022 18.1; FY2023 20.1. - Total Expenditure (percent of GDP): FY2018 39.7; FY2019 38.5; FY2020 41.3; FY2021 50.6; FY2022 42.3; FY2023 43.4. - Overall balance (percent of GDP): FY2018 2.9; FY2019 3.2; FY2020 4.4; FY2021 -4.8; FY2022 -0.3; FY2023 1.0. - Composition: - Expense (percent of GDP): FY2018 31.4; FY2019 30.3; FY2020 35.4; FY2021 44.4; FY2022 35.6; FY2023 34.9. - Net investment in nonfinancial assets (percent of GDP): FY2018 8.3; FY2019 8.3; FY2020 5.9; FY2021 6.2; FY2022 6.7; FY2023 8.5. - Donor support and grants: - Donors stepped up aid in the form of grants. - Rising pandemic-related spending and the wage bill were offset by delayed investments, resulting in large unspent reconstruction-related grants. - For FY2020, an estimated 25 million (2.2 percent of GDP) of spending is related to the COVID-19. For FY2021, an estimated 70 million (6.4 percent of GDP) of spending is related to the pandemic. - Debt: - Public debt (external and domestic, percent of GDP): FY2018 45.9; FY2019 41.3; FY2020 42.3; FY2021 46.3; FY2022 44.6; FY2023 42.7. - External debt (percent of GDP): FY2018 40.5; FY2019 36.4; FY2020 36.2; FY2021 38.5; FY2022 35.1; FY2023 31.6. - External debt service ratio: FY2018 1.2; FY2019 1.7; FY2020 1.5; FY2021 2.0; FY2022 1.8; FY2023 2.0. - Public legacy debt levels, while declining, remain high. ### Projections and medium-term baseline (selected) - Medium-term baseline projections (FY2024–FY2025 highlights): - Real GDP: FY2024 2.5; FY2025 1.8. - Consumer prices (end of period): FY2024 2.3; FY2025 2.3. - Total Revenue (percent of GDP): FY2024 34.6; FY2025 32.3. - Total Expenditure (percent of GDP): FY2024 42.7; FY2025 42.3. - Overall Balance (percent of GDP): FY2024 -8.1; FY2025 -10.0. - Gross international reserves (end of period, millions USD): FY2024 149.2; FY2025 149.9. - Public sector total debt (percent of GDP): FY2024 49.1; FY2025 57.3. - Current account balance (In percent of GDP): FY2024 -11.8; FY2025 -11.7. - Remittances (Memorandum, percent of imports of goods and services): FY2024 33.4; FY2025 33.0. - FY2025 incorporate the average effect of natural disasters. ### External financing and IMF-related indicators - External financing requirements and sources (selected, millions USD): - Total requirement (Estimate row series): FY2019 10.3; FY2020 24.4; FY2021 123.1; FY2022 57.8; FY2023 56.1; FY2024 89.0; FY2025 91.1. - Current account deficit (excluding the budget support from the World Bank for FY2021): FY2019 4.4; FY2020 19.6; FY2021 115.9; FY2022 50.5; FY2023 46.9; FY2024 68.0; FY2025 70.2. - Amortization: FY2019 5.9; FY2020 4.8; FY2021 7.2; FY2022 7.3; FY2023 9.2; FY2024 21.0; FY2025 20.9. - Total sources: FY2019 8.1; FY2020 53.5; FY2021 28.4; FY2022 34.6; FY2023 34.7; FY2024 90.5; FY2025 91.8. - Financing gap (- = excess of financing): FY2019 2.1; FY2020 -29.1; FY2021 94.7; FY2022 23.2; FY2023 21.4; FY2024 -1.5; FY2025 -0.7. - Use of IMF credit (net) / Disbursement (RCF): FY2020 0.0; FY2021 9.7; FY2022 0.0; FY2023 0.0. - Indicators of capacity to repay the IMF (selected): - Outstanding IMF credit (Millions of SDRs): FY2020 0.0; FY2021 6.9; FY2022 6.9; FY2023 6.9; FY2024 6.9; FY2025 6.9; FY2026 6.9; FY2027 6.9; FY2028 6.9; FY2029 6.9; FY2030 6.9; FY2031 6.9; FY2032 6.9; FY2033 6.9. - Outstanding IMF credit (Millions of Tonga): FY2020 0.0; FY2021 21.6; FY2022 21.8; FY2023 21.9; FY2024 22.0; FY2025 22.1; FY2026 22.2; FY2027 17.9; FY2028 13.5; FY2029 9.0; FY2030 4.5; FY2031 0.0; FY2032 0.0; FY2033 0.0. - Percent of quota: FY2020 0.05; FY2021 50.0; FY2022 50.0; FY2023 50.0; FY2024 50.0; FY2025 50.0; FY2026 50.0; FY2027 40.0; FY2028 30.0; FY2029 20.0; FY2030 10.0; FY2031 0.0; FY2032 0.0; FY2033 0.0. - Net use of IMF credit (SDR): FY2020 0.0; FY2021 6.9; FY2022 0.0; FY2023 0.0; FY2024 0.0; FY2025 0.0; FY2026 -1.4; FY2027 -1.4; FY2028 -1.4; FY2029 -1.4; FY2030 -1.4; FY2031 0.0; FY2032 0.0; FY2033 0.0. *Sources: Tonga authorities; and IMF staff estimates and projections.* ### References ### 1tonea2021001 - References ### References cited - Barajas A., R. Chami, C. Fullenkamp, M. Gapen and P. Montiel, 2009, “Do Workers’ Remittances Promote Economic Growth?” IMF Working Paper, WP/09/153. - Barajas A., R. Chami, C. Ebeke and A. Oeking, 2016, “What’s Different about Monetary Policy Transmission in Remittance-Dependent Countries?” IMF Working Paper, WP/16/44. - Batini N., L. Eyraud, L. Forni and A. Weber, 2014, “Fiscal Multipliers: Size, Determinants, and Use in Macroeconomic Projections,” IMF Technical Notes and Manuals. - Chami R., E. Ernst, C. Fullenkamp, and A. Oeking, 2018a, “Are Remittances Good for Labor Markets in LICs, MICs and Fragile States? Evidence from Cross-Country Data” IMF Working Paper, WP/18/102. - Chami R., E. Ernst, C. Fullenkamp, and A. Oeking, 2018b, “Is There A Remittance Trap?” IMF Finance and Development, September 2018. - Daniel J., Banerji A., Blackman A., Esler S., Moeaki T., Neves R., Palu N., Paitkov N., Prihardini D., Sandoz C., and Zdzienicka A., 2020, “Kingdom of Tonga Climate Change Policy Assessment,” IMF Technical Assistance Report, June 2020. - Griffin N., Y. Sugayama, and M. Flynn, 2017, “Enhancing the Monetary Policy Framework and Developing Securities Market,” IMF Technical Assistance Report, February 2017, unpublished. - Liu L., P. Mullins, T. Matsudaira, and G. Eysselein, 2019, “Kingdom of Tonga: Tax Reform Options to Replace Expected Revenue Shortfall from PACER Plus,” IMF Technical Assistance Report, May 2019, unpublished. - Liu L., and P. Mullins, 2020, “Tonga: A Roadmap to Reduce Tax Exemptions,” IMF Technical Assistance Report, June 2020, unpublished. - Kubasta C., R. Neves, K. Kaufmann, M. Bowen, U. Zrinski, and K. Ravono, 2020, “Public Expenditure and Financial Accountability (PEFA) Performance Assessment Report (draft)”, IMF Technical Assistance Report, June 2020. - Sutherland, L., 2019, “Tonga—Expanding the Heilala Tax System and Establishing LTO,” IMF Technical Assistance Report, October 2019, unpublished. - World Bank, 2017, Pacific Possible: Long-term Economic Opportunities and Challenges for Pacific Island Countries. Washington, DC: World Bank. - World Bank, 2020, Doing Business, Washington, DC: World Bank. ### Annex I — Progress on IMF 2017 Article IV Recommendations - Fiscal policies - Recommendation: Targeting a gradual adjustment of the primary balance to approximately 1 percent of GDP by FY2022 through revenue and expenditure measures to ensure debt sustainability. - Actions since 2017: Fiscal consolidation which started in FY2016 continued through FY2020 with donor grants. FY2019-20 surplus reflected continued strength in revenue collection and controls on current spending. Weaknesses: healthcare and overtime-related cost overruns, delayed investments and maintenance spending. - PFM recommendation: Further strengthen PFM for medium-term planning, accountability, budget control, and efficient use of public funds. - PFM actions: Ongoing. 2019 PEFA identified relatively sound PFM processes. Budget planning and preparation generally sound; budget reliability weak due to variation in aggregate spending and revenue composition and over/underspending of budget support and development funds. - Monetary policy - Recommendation: Maintain supportive stance; stand ready to adjust if risks emerge. - Actions: Monetary policy rate maintained at 0 percent, statutory reserve deposit rate at 10 percent and inflation reference rate at 5 percent. - Recommendation: Consider more flexible liquidity management tools (e.g., short-term NRBT securities). - Actions: Ongoing. Measures to manage excess liquidity while ensuring adequate liquidity. NRBT introduced a minimum loan-to-deposit ratio and allowed pension funds to transfer balances abroad. - Financial sector policies - Recommendation: Strengthen monitoring of financial institutions and NRBT supervisory capacity. - Actions: Microfinance Institutions Act effective June 2019; Moneylenders Act effective September 2020. Financial Institutions Act amended and renamed the Banking Act. Onsite examinations and spot checks continued. Annual financial reports from NBFIs mandatory. Improvements in insurance regulations underway. - Recommendation: Ensure AML/CFT regulations satisfy international standards. - Actions: Cabinet Committee endorsed Tonga’s National AML/CFT Risk Assessment Report and first National AML/CFT Strategy in October 2019. APG assessment underway. - Structural policies - Recommendation: Improve business environment, develop private sector, formalize MSMEs. - Actions: Employment Relations Bill approved by Cabinet with maternity leave and protections; draft amendments to 2018 FEC Act submitted to Cabinet; government investing in TVET; Tonga Development Bank continued lending to MSMEs. - Recommendation: Invest in climate-resilient infrastructure. - Actions: In line with Tonga Energy Road Map, investments in renewable energy ramped up, funded by donors. Implementation of other investments delayed, including by the pandemic. - Statistics - Recommendation: Improve main macroeconomic datasets including BOP, fiscal and national account statistics. - Actions: More resources to Tonga Statistics Department, increased staff numbers, new strategy adopted to turnover. Staff training revamped (online training and more staff trained at once), initiatives to foster transfer of skills and handover processes. ### Annex II — External Sector Assessment (key findings and figures) - FY2020 external position assessment - The external sector position for FY2020 is broadly in line with the level implied by fundamentals and desirable policy settings. - Current account (CA) deficit widened to 3.9 percent in FY2020 from 0.9 percent in FY2019. - Historical average CA deficits: some 6 percent of GDP over FY2015−19. - EBA-Lite CA model indicates a CA gap of 0.9 percent of GDP in FY2020. - Projection: CA expected to widen substantially in FY2021 due to a sharp drop in tourism, lower remittance inflows, and strong imports of health-related goods; deficits projected to remain large in subsequent years. - EBA-Lite model results for FY2020 (In percent of GDP, unless otherwise indicated) - CA-Actual-3.9 - Cyclical contributions (from model)-0.2 - Additional temporary/statistical factors0.0 - Natural disasters and conflicts1.0 - Adjusted CA-4.7 - CA Norm (from model) 1/-7.5 - Adjustments to the norm 2/1.9 - Adjusted CA Norm-5.6 - CA Gap0.9 - o/w Policy gap4.7 - Elasticity-0.25 - REER Gap (in percent)-3.8 - Exchange rate and competitiveness - REER depreciated by 2.7 percent on average in FY2020. - Drivers: depreciation of nominal effective exchange rate (NEER), Tonga’s lower headline inflation relative to trading partners. - Structural constraints: weak export competitiveness due to limited capacity for high-value added production, concerns about overfishing limiting marine export growth, agricultural export losses from cyclone damage, difficulties meeting quality and phytosanitary requirements in principal markets (Australia and New Zealand). - Tourism potential limited short-to-medium term by limited capacity (e.g., hotels), gaps in tourism-related infrastructure, delays in rebuilding after Cyclones Gita and Harold, and Tonga’s remoteness; travel restrictions reduce near-term expansion prospects. - Capital and financial accounts - Recent CA deficits largely financed by capital and financial account flows driven by donor project-related grants. - NRBT implemented Foreign Exchange Control (FEC) Act in 2018 clarifying repatriation and surrender requirements if reserves fell below 2 months of imports. Amendments under consideration. - International reserves and adequacy - Actual reserves: US$241 million at end-FY2020 (about 9.6 months of imports coverage). - Reserves further increased to US$251 million by end-October 2020 due to additional emergency grants related to Covid-19 (not yet fully spent). - Projection: Reserve coverage projected to decline to about 4 months of prospective imports by FY2025 due to reconstruction imports and rising debt repayments. - Reserve adequacy model outputs: - Optimal level with standard shock probability4.1 (months of imports) - Optimal level with higher shock probability6.6 (months of imports) - Optimal level taking into account debt repayment7.3 (months of imports) - Broad Money coverage309% - Debt repayment and additional buffer needs - Amortization between FY2020 and FY2023 averages around US$6.1 million per year. - Amortization in FY2024 jumps to US$21.0 million with the Export-Import Bank of China (China Eximbank) loan coming due. - Recommendation: Accumulate an additional US$91 million in reserves to finance rising debt repayments between FY2024−29. This implies US$21 million per year during FY2021−23 after accounting for already accumulated reserves of US$29 million in FY2020, equivalent to an additional 0.7 months of imports. - Optimal reserve level, accounting for higher risk and upcoming repayments, estimated at around 7.3 months of imports. - Reserve adequacy table (FY2020) - Actual Reserves (months of prospective imports)9.6 - Optimal level with standard shock probability4.1 - Optimal level with higher shock probability6.6 - Optimal level taking into account debt repayment7.3 - Broad Money coverage309% ### Risk Assessment Matrix — Sources, likelihood, impact, and policy responses - External risks - Unexpected shift in the Covid-19 pandemic — Likelihood: H; Impact: H. - Effects: Reduced remittances, donor funds, delayed tourism resumption; pressures on exchange rate, reserves, consumption, growth; deterioration in public sector and financial sector balance sheets. - Policies: Targeted fiscal support, continued monetary and liquidity support, clear communication, enhanced financial-sector vigilance, build external and fiscal buffers, ensure financial-sector resilience. - Accelerating deglobalization — Likelihood: H; Impact: H. - Policies: Same as above; undertake fiscal rebalancing to support vulnerable, improve healthcare/testing/tracing, public investment and climate resilience while ensuring debt sustainability. - Widespread social discontent and political instability — Likelihood: H; Impact: H. - Policies: Accelerate financial sector reforms, improve private sector business climate, diversify the economy, build capacity to improve utilization of donor funds. - Intensified geopolitical tensions and security risks — Likelihood: H; Impact: H. - Policies: As above. - Domestic risks - Higher frequency and severity of natural disasters related to climate change — Likelihood: H; Impact: H. - Policies: Reduce fossil fuel intensity by raising renewable energy share, invest in climate-resilient infrastructure, improve government reconstruction capacity, maintain adequate fiscal buffers. - Worsening debt dynamics due to the pandemic — Likelihood: H; Impact: H. - Policies: Strengthen tax revenues by gradually eliminating tax exemptions and improve tax administration; curtail non-essential spending; reduce wage bill through remuneration reforms; improve prioritization and pace of investment spending on climate-resilient projects by improving capacity. - Financial stability risks due to pandemic — Likelihood: M; Impact: M. - Policies: Enhance financial stability framework, proactively manage risks in bank and nonbank sectors, develop macroprudential framework, improve financial deepening. - Partial withdrawal of Correspondent Banking Relationships (CBRs) due to gaps in AML/CFT framework — Likelihood: M; Impact: M. - Policies: Strengthen legal and regulatory framework and effective implementation of AML/CFT framework, improve risk-based supervision and enforcement in line with ongoing APG assessment. *Italicized line: Source: IMF staff compilation from the “References” and annexes contained in the provided content unit.* ### Annex IV. Spending Needs to Achieve Sustainable Development ### Annex IV. Spending Needs to Achieve Sustainable Development Goals and Improve Climate Resilience ### Progress and quantified spending needs - Progress toward meeting SDG and climate goals has been mixed; substantial challenges persist and are likely to be further exacerbated by the pandemic. - Public spending on SDG and climate goals, mainly supported by development partners, increased over the past years, improving access to, and the quality of, physical infrastructure, health, and education. - IMF staff estimate that additional annual spending to achieve the five SDGs amounted to about 7 percent of GDP in 2030 (left bar). - The authorities’ climate projects (middle bar) significantly overlapped with IMF staff estimates, but did not include additional spending needs mainly in health and education. - Accounting for IMF staff estimates of spending needs to meet SDG targets and the authorities’ plans to increase resilience amounts to a total additional annual spending need of about 13 percent of 2030 GDP in 2030 (right bar). - The pandemic has exacerbated persistent existing challenges (e.g., related to the health system), adding to the already large spending needs in the health sector. - Footnote: Identified authorities’ projects are already included in staff baseline projections. ### Key policy recommendations and priorities - Develop and adopt better-designed sectoral strategies and national plans: - Prepare new national health, education, and strategic investment plans that clearly define and prioritize development objectives and channel financial and technical resources toward those objectives. - Strengthen fiscal, spending, and public financial management frameworks: - Improve spending efficiency and public financial management practices. - Enhance domestic revenue mobilization to support prioritized spending. - Mobilize and coordinate external support: - Secure further external assistance on technology, technical skills upgrade, capacity building, and statistics to sustain progress and cushion pandemic impacts. - Additional grant support is essential ("sine qua non") to avoid exacerbating already-high debt levels. - Implementation sequencing and capacity building: - Ensure implementation of sectoral strategies goes hand-in-hand with capacity strengthening to deliver climate-resilient and sustainable development investments. *Prepared by Aleksandra Zdzienicka (FAD) based on information available as of February 2020.* ### 14. We recognize the importance of good governance, transparency and accountability. We are ### 1tonea2021001 - 14. We recognize the importance of good governance, transparency and accountability. We are ### Good governance, transparency, and safeguards - Commitments by the authorities: - Publish on the government’s website: - (i) an audit of COVID-19 related expenditures by the Audit Department within 9-12 months. - (ii) pandemic-related public procurement contracts and related documents, including owners of awarded companies. - Make every effort to identify beneficial owners of awarded companies. - Undertake, in line with the IMF’s safeguards policy, a safeguards assessment of the NRBT in collaboration with IMF staff: - Provide IMF staff with NRBT’s most recently completed external audit reports. - Coordinate meetings of IMF staff with the staff in charge of these issues in the NRBT. - Authorize IMF staff to hold discussions with NRBT’s external auditors. ### IMF engagement, policy stance, and commitments - Authorities’ stance: - Reaffirm willingness to remain engaged with the IMF for policy advice, capacity development support, and financial support as needed. - Commit to ensuring continued macroeconomic stability and to avoid measures that may compound difficulties or exacerbate balance of payments difficulties. - Continue to comply with the provision of the IMF’s Articles of Agreement, including those related to not imposing new or intensifying existing restrictions on the making of payments and transfers for current international transactions and bilateral payments under Article VIII. - Authorize the IMF to publish this letter, the Staff Report of Article IV consultation, and the request for purchase under the RCF. ### Fund relations and key financial positions (as of November 19, 2020) - Membership Status: Joined September 28, 1981; Article VIII - General Resources Account: - Quota 13.80 100.00 - Fund holdings of currency 10.36 75.1 - Reserves tranche position 3.44 24.9 - SDR Department: - Net cumulative allocations 6.58 100.00 - Holdings 5.42 82.41 - Outstanding Purchases and Loans: None - Latest Financial Arrangements: None - Projected Payments to the Fund (SDR million; forthcoming): - Principal: 0.0 0.0 0.0 0.0 0.0 0.0 1.4 1.4 1.4 1.4 1.4 0.0 - Charges/Interest: 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 - Total: 0.0 0.0 0.0 0.0 0.0 0.0 1.4 1.4 1.4 1.4 1.4 0.0 ### Exchange arrangement and statistics capacity - Exchange arrangement: - De jure: pegged exchange rate within horizontal bands. - External value of the pa’anga: weighted currency basket comprising the U.S. dollar, Australian dollar, New Zealand dollar, and Fijian dollar. - Intervention currency: U.S. dollar; the exchange rate of the pa’anga in terms of the U.S. dollar is fixed daily by the NRBT within a band of ±5% a month. - De facto classification: “other managed” (reclassified effective January 1, 2019). - Statistics and data adequacy: - National accounts: capacity limited; annual national accounts compiled by production and expenditure approaches; experimental quarterly national accounts estimates compiled with PFTAC assistance in November 2020. - CPI: updated in 2018 based on 2015–16 HIES; estimated monthly with lags; coverage expanded to Vava’u Division. - GFS: migrated to GFS2014; timeliness and in-year reporting remain issues; IFMS not upgraded; debt management conducted outside financial accounts; aid revenue not included in financial accounts. - Monetary and financial statistics: NRBT reports SRFs for central bank, other depository corporations, and monetary aggregates. - External sector statistics: shortcomings in accuracy, completeness, timeliness, and classification; October 2020 CDOT mission assisted improvements and initiation of international investment position compilation. - e-GDDS: participating since May 30, 2006; e-GDDS mission in October 2020 to assist launch of NSDP tentatively scheduled for end-2020 to disseminate 13 of the 15 e-GDDS data categories. ### Debt profile, risks, and debt sustainability analysis (DSA) - Risk ratings: - Risk of external debt distress: High - Overall risk of debt distress: High - Granularity in the risk rating: Sustainable - Application of judgment: No - Key DSA findings and projections: - Tonga’s indebtedness has gradually declined since end-FY 2015 as fiscal consolidation started in FY2016 and continued through FY2020 notwithstanding the Covid-19 pandemic. - The PV of the external debt-to-exports ratio is expected to temporarily breach the indicative threshold under the baseline scenario in FY2021 mainly due to the decline of exports triggered by the pandemic. - Without new grant commitments, both external solvency indicators (the PV of the external debt-to-GDP ratio and of the external debt-to-exports ratio) are expected to breach their respective thresholds under the baseline scenario starting in FY2029. - The PV of the public debt-to-GDP ratio is expected to breach the benchmark starting from FY 2029 under the baseline scenario. - A tailored one-time natural disaster shock would imply a significant deterioration in debt sustainability. - Long-term debt sustainability hinges on fiscal adjustment, continued donor grant inflows, and debt relief; continued grant financing consistent with historical levels would help stabilize external debt dynamics. - Policy recommendations to rebuild buffers and resilience: - Stronger revenue mobilization measures. - Expenditure rationalization. - Effective debt management strategies. - Debt composition and quantities (end-June 2020 and related notes): - Public debt coverage: includes obligations of the central government and central bank; central bank’s debt borrowed on behalf of the government. - Government-guaranteed debt: about 1 percent of GDP as of end-June 2020. - Additional contingent liability test additions: - Non-included SOE debt added as 2 percent of GDP. - Standard 5 percent of GDP cost to the government of a financial crisis. - Total added for tests: 7.0 percent of GDP (2.0 + 5.0). - Public debt level: 42 percent of GDP at end-June 2020. - Public debt trajectory: declined from 51 percent at end-June 2015 to 42 percent at end-June 2020. - External vs. domestic debt: Tonga's debt obligations are largely external; 85 percent of total public debt is external as of end-June 2020. - Total public and publicly guaranteed (PPG) external debt: USD184 million (about 36 percent of GDP) as of end-June 2020. - Outstanding debt to multilateral creditors: USD75 million (about 15 percent of GDP), some 41 percent of the total external debt stock. - Largest creditor: Export-Import Bank of China (China Eximbank) accounting for 58 percent of total external debt stock. - Repayment profile: - Tonga started repayments to China Eximbank in FY2019 with larger repayments coming due starting in FY2024. - Tonga’s request for a temporary suspension of its calendar year 2020 debt service to China Eximbank under the G20 Debt Service Suspension Initiative (DSSI) has been accepted and rescheduled debt repayments are included in the baseline scenario. - Baseline scenario also incorporates rescheduled debt service repayments to China Eximbank coming due during the first half of calendar year 2021 reflecting the extension of the DSSI to that period. ### Country capacity and indicators referenced - Tonga Composite Indicator (CI) index: 3.12 (based on October 2020 WEO and 2019 CPIA), indicating Tonga’s debt-carrying capacity is strong (shift from moderate to strong compared to 2017 DSA). - Fiscal year convention: FY runs from July 1 to June 30 (e.g., FY2020 runs from July 1, 2019 to June 30, 2020). - Remaining loan commitment: about 0.4 percent of GDP. - Tonga does not have arrears to external creditors. *Prepared by the staffs of the International Monetary Fund and the International Development Association; December 18, 2020.* ### 4. Tonga's domestic debt obligations are relatively small. Public domestic debt stood at ### 4. Tonga's domestic debt obligations are relatively small. Public domestic debt stood at ### Domestic debt stock and holders - Public domestic debt stood at USD31 million (about 6 percent of GDP) at end-June 2020, accounting for 15 percent of total public debt. - Domestic financial institutions hold about half of the total domestic debt. - The remainder of domestic debt is held mainly by domestic pension funds, including: - Retirement fund board - National retirement benefits fund - Public enterprises - Individuals - Staff (provident funds) - Insurance - Others - The authorities plan to issue domestic debt in FY2021 and beyond, if necessary. ### Outstanding external public debt composition (June 2020) and currency note - Outstanding External PPG Debt by Creditor, June 2020 (in percent of total external PPG debt): - China Eximbank: 58.4 - IDA: 23.5 - ADB: 16.0 - IFAD: 2.1 - Note: The loans from China Eximbank are denominated in Chinese renminbi. ### Repayment schedule for existing external debt, FY2020–30 (in percent of GDP) - Total external debt repayments by fiscal year: - FY2020: 1.0 - FY2021: 0.6 - FY2022: 1.4 - FY2023: 1.7 - FY2024: 3.6 - FY2025: 3.5 - FY2026: 3.3 - FY2027: 3.1 - FY2028: 2.9 - FY2029: 2.0 - FY2030: 1.0 - Multilateral repayments (in percent of GDP) by fiscal year: - FY2020: 0.6 - FY2021: 0.6 - FY2022: 0.5 - FY2023: 0.5 - FY2024: 0.5 - FY2025: 0.6 - FY2026: 0.6 - FY2027: 0.5 - FY2028: 0.5 - FY2029: 0.5 - FY2030: 0.4 - ADB repayments (in percent of GDP) by fiscal year: - FY2020: 0.4 - FY2021: 0.4 - FY2022: 0.4 - FY2023: 0.4 - FY2024: 0.3 - FY2025: 0.4 - FY2026: 0.4 - FY2027: 0.3 - FY2028: 0.3 - FY2029: 0.2 - FY2030: 0.2 - IDA/WB repayments (in percent of GDP) by fiscal year: - FY2020: 0.1 - FY2021: 0.1 - FY2022: 0.1 - FY2023: 0.1 - FY2024: 0.1 - FY2025: 0.2 - FY2026: 0.2 - FY2027: 0.2 - FY2028: 0.2 - FY2029: 0.2 - FY2030: 0.2 - IFAD repayments are 0.0 percent of GDP each year FY2020–FY2030. - Bilateral repayments (in percent of GDP) by fiscal year: - FY2020: 0.4 - FY2021: 0.0 - FY2022: 0.9 - FY2023: 1.1 - FY2024: 3.1 - FY2025: 2.9 - FY2026: 2.7 - FY2027: 2.6 - FY2028: 2.4 - FY2029: 1.6 - FY2030: 0.6 - EXIM Bank of China (post DSSI) repayments (in percent of GDP) by fiscal year: - FY2020: 0.4 - FY2021: 0.0 - FY2022: 0.9 - FY2023: 1.1 - FY2024: 3.1 - FY2025: 2.9 - FY2026: 2.7 - FY2027: 2.6 - FY2028: 2.4 - FY2029: 1.6 - FY2030: 0.6 - Memorandum item — EXIM Bank of China (pre-DSSI) repayments (in percent of GDP) by fiscal year: - FY2020: 0.4 - FY2021: 0.9 - FY2022: 0.9 - FY2023: 0.8 - FY2024: 2.8 - FY2025: 2.7 - FY2026: 2.6 - FY2027: 2.5 - FY2028: 2.4 - FY2029: 1.6 - FY2030: 0.6 - Note: Repayments are around 0.03 percent of GDP per year for IFAD 1/. ### Baseline macroeconomic assumptions (selected indicators) - Real GDP growth (in percent): - FY2020: -2.5 - FY2021: -3.5 - FY2022: 4.0 - FY2023: 3.0 - FY2024: 2.5 - FY2025: 1.8 - FY2026: 1.8 - FY2027: 1.8 - FY2028: 1.8 - FY2029: 1.8 - FY2030: 2.3 - FY2009-19 Historical average: 1.3 - FY2020-30 average: 1.3 - GDP deflator in US dollars (change in percent): - FY2020: 0.0 - FY2021: 0.9 - FY2022: 3.1 - FY2023: 1.9 - FY2024: 1.9 - FY2025: 1.9 - FY2026: 2.0 - FY2027: 2.1 - FY2028: 2.1 - FY2029: 2.1 - FY2030: 3.1 - FY2020-30 average: 1.8 - Non-interest current account deficit (in percent of GDP): - FY2020: 3.3 - FY2021: 18.3 - FY2022: 9.1 - FY2023: 8.1 - FY2024: 11.5 - FY2025: 11.3 - FY2026: 13.6 - FY2027: 13.2 - FY2028: 13.2 - FY2029: 13.0 - FY2030: 13.1 - FY2009-19 Historical average: 9.8 - FY2020-30 average: 11.6 - Net FDI (negative = inflow, in percent of GDP): - FY2020: -0.7 - FY2021: -0.9 - FY2022: -0.9 - FY2023: -0.8 - FY2024: -0.7 - FY2025: -0.7 - FY2026: 0.0 - FY2027: -0.7 - FY2028: -0.7 - FY2029: -1.0 - FY2030: -1.0 - FY2009-19 Historical average: -1.3 - FY2020-30 average: -0.8 - Primary deficit (in percent of GDP): - FY2020: -5.2 - FY2021: 4.0 - FY2022: -0.4 - FY2023: -1.5 - FY2024: 7.4 - FY2025: 9.3 - FY2026: 16.0 - FY2027: 16.4 - FY2028: 16.7 - FY2029: 16.7 - FY2030: 16.7 - FY2009-19 Historical average: -1.3 - FY2020-30 average: 8.7 - Grants (in percent of GDP): - FY2020: 21.0 - FY2021: 22.9 - FY2022: 18.1 - FY2023: 20.1 - FY2024: 10.5 - FY2025: 8.1 - FY2026: 0.8 - FY2027: 0.8 - FY2028: 0.7 - FY2029: 0.7 - FY2030: 0.7 - FY2009-19 Historical average: 13.7 - FY2020-30 average: 9.5 - Inflation (measured by GDP deflator in USD terms) is projected to average 1.8 percent during FY2020–30 given current projections of low global food and fuel prices. ### Key fiscal and reserve dynamics and implications - Real GDP growth is projected at 1.3 percent on average during FY2020–30. - Economic activity is expected to contract by 2.5 percent and 3.5 percent respectively in FY2020 and FY2021. - The non-interest current account deficit is projected to widen to 11.6 percent of GDP on average over FY2020–30. - Net FDI inflows are expected to stand at 0.8 percent of GDP over FY2020–30. - New external borrowing is expected to commence in FY2024 (with the exception of IMF RCF-supported financing and rescheduled China Eximbank repayments under the DSSI) and increase gradually over the medium-term to refinance debt repayments and the primary deficit which is expected to reach double digits over FY2026–2030. - The level of international reserves is expected to be sufficient to cover external debt repayments coming due until FY2023. - Large repayments to China Eximbank start coming due beginning in FY2024 (annual payments of about 2.5 percent of GDP in FY2024–29 on average), creating a risk that authorities would not have enough cash buffers for debt repayments unless they borrow, or risk compromising the central bank’s minimum reserve adequacy benchmark of at least 3–4 months of imports of goods and services. ### Public finance outlook and natural disaster assumptions - Fiscal outlook: - The average primary balance is expected to be at -8.7 percent of GDP per year during FY2020–30. - The primary balance is expected to decline from a surplus in FY2019–20 to a deficit of 16.7 percent of GDP by FY2030. - Deterioration in FY2021 reflects a sharp economic contraction due to the Covid-19 pandemic and increased health and social spending needs. - Natural disaster assumptions: - The baseline incorporates the average long-term effects of natural disasters and climate change from FY2025 onwards by lowering annual GDP growth by 0.16 percentage points. - A tailored one-time natural disaster shock for FY2021 assumes a one-off shock of 14 percentage points (ppts) to the debt-to-GDP ratio in FY2021, with real GDP growth and exports lowered by 3 and 7 ppts, respectively, in the year of the shock. ### Debt sustainability findings and stress tests - Tonga's Composite Indicator (CI) index is 3.12, indicating that the country's debt-carrying capacity is strong according to the revised LIC-DSA framework. - Under the baseline scenario: - External debt-to-GDP ratio increases from 36 percent in FY2020 to 38 percent in FY2021. - External debt-to-GDP ratios decline to 32 percent in FY2023, then rise; external debt is projected to breach the authorities’ fiscal anchor of 50 percent in FY2026. - The PV of the external debt-to-GDP ratio is expected to breach the threshold of 55 percent starting from FY2029. - Debt service indicators sharply increase in FY2024 to reach 18 percent of exports and 16 percent of revenue as larger payments to China Eximbank start coming due. - Stress test results: - A combination of diverse shocks and an export shock have the largest negative impact on external debt trajectories. - The tailored natural disaster shock causes the PV of external debt- and exports-to-GDP ratios to rise after the shock; multiple disasters within ten years could produce a larger cumulative negative effect. - Public debt sustainability: - Under the baseline, the PV of the public debt-to-GDP ratio would cross the 70 percent benchmark from FY2029 onwards. - The total public debt-to-GDP ratio would rise from 42 percent of GDP in FY2020 to reach 72 percent of GDP in FY2026. - Standardized sensitivity analysis indicates an earlier breach in FY2027 under multi-year shocks to real GDP growth, exports, and a natural disaster shock. - A tailored combined contingent liability shock shifts the PV of the public debt-to-GDP trajectory upwards by 4 ppts from the baseline. ### Risk rating, vulnerabilities, and policy implications - The 2020 DSA suggests Tonga's risk of external debt distress remains high. - The overall risk of debt distress is also high, with the PV of the public debt-to-GDP ratio remaining above the indicative benchmark from FY2029 onwards. - Tonga is highly vulnerable to natural disaster, growth, and exports shocks. - Policy recommendations and implications: - Urgent need for fiscal adjustments and measures to boost potential growth in the long run. - Post-pandemic, authorities need to embark on fiscal consolidation measures to rebuild fiscal buffers. - Prioritize investment projects that improve resilience to natural disasters and raise potential growth. - New donor grant commitments and debt relief would be helpful. *Sources: Ministry of Finance; and IMF staff estimates.* ### 18. The authorities agreed with the debt sustainability assessment, in particular the implications of ### 1tonea2021001 - 18. The authorities agreed with the debt sustainability assessment, in particular the implications of ### Authorities' assessment and policy commitments - The authorities agreed with the debt sustainability assessment, in particular the implications of large debt repayments and potential negative shocks to growth, including from natural disasters. - Recognized need to build adequate fiscal buffers once the pandemic is over. - Reiterated commitments to: - improve the targeting of economic support; - further improve revenue administration; - implement spending controls; - broaden the tax base in line with recommendations made by the previous and ongoing IMF and World Bank technical assistance. - Will continue to seek new grant financing commitments from bilateral donors and international financial institutions, and additional debt relief from China Eximbank, to maintain public and external debt at prudent levels. - Commit to refrain from non-concessional borrowing. - Plan to report contingent debt to improve debt coverage. - A medium-term debt strategy is under preparation and will reflect these priorities. ### Key fiscal and financing facts - Cash and in-kind grants averaged 16.7 percent of GDP annually over FY2015–2019. - Gross external financing need (Million of U.S. dollars): 38.7, 10.0, 10.0, 20.7, 88.6, 53.3, 51.6, 84.7, 86.8, 103.7, 107.9, 110.1, 107.8, 109.8, 138.0. - Nominal GDP (Million of US dollars): 460, 486, 517, 504, 491, 526, 552, 576, 598, 621, 646, 671, 698, 725, 1,082. - Nominal dollar GDP growth: 9.5, 5.5, 6.4, -2.5, -2.6, 7.2, 4.9, 4.5, 3.8, 3.9, 4.0, 3.9, 3.9, 4.1, 5.4, 3.2 (series as presented). ### External debt and related indicators (selected series) - External debt (nominal) 1/: 38.7, 40.5, 36.4, 36.2, 38.5, 35.1, 31.6, 37.8, 45.7, 59.6, 73.6, 87.3, 100.5, 113.5, 143.1, 41.7, 59.9 (series as presented). - Change in external debt: -3.2, 1.8, -4.2, -0.2, 2.3, -3.4, -3.4, 6.2, 7.9, 13.9, 14.0, 13.7, 13.2, 13.0, -0.3. - Identified net debt-creating flows: 4.1, -0.6, -1.6, 4.1, 17.9, 7.3, 6.7, 10.3, 10.4, 12.6, 12.2, 11.9, 11.5, 11.6, 4.3, 7.5, 10.6. - Non-interest current account deficit: 5.7, 5.7, 0.0, 3.3, 18.3, 9.1, 8.1, 11.5, 11.3, 13.6, 13.2, 13.2, 13.2, 13.1, 6.4, 9.8, 11.6. - PV of PPG external debt-to-GDP ratio (selected projection series): 25.4, 26.0, 29.5, 27.1, 25.0, 27.7, 31.7, 38.6, 45.8, 53.2, 61.0, 69.1, 88.8 (series as presented). - PV of PPG external debt-to-exports ratio (selected projection series): 115.5, 138.3, 764.1, 146.9, 133.3, 129.2, 142.2, 168.6, 197.7, 227.8, 261.1, 290.7, 329.5. - PPG debt service-to-exports ratio (selected series): 6.0, 5.8, 9.1, 8.1, 17.9, 10.1, 10.1, 8.5, 17.5, 17.5, 16.7, 18.0, 17.6, 14.7, 12.8, 28.3. ### Macroeconomic assumptions (selected) - Real GDP growth (in percent): 3.3, 0.3, 0.7, -2.5, -3.5, 4.0, 3.0, 2.5, 1.8, 1.8, 1.8, 1.8, 1.8, 1.8, 2.3, 1.3 (series as presented). - GDP deflator in US dollar terms (change in percent): 5.9, 5.2, 5.6, 0.0, 0.9, 3.1, 1.9, 1.9, 1.9, 2.0, 2.1, 2.1, 2.1, 2.1, 2.3, 3.1, 1.8 (series as presented). - Effective interest rate (percent) 4/: 1.7, 1.6, 2.3, 1.5, -2.1, 1.3, 1.2, 1.1, 1.1, 1.2, 1.2, 1.2, 1.2, 1.3, 1.2, 1.7, 0.9 (series as presented). - Growth of exports of G&S (US dollar terms, in percent): -1.1, 1.9, 9.1, -16.6, -80.0, 411.2, 6.9, 19.4, 7.7, 6.9, 5.0, 4.9, 4.0, 5.7, 5.8, 12.1, 34.1 (series as presented). ### Public sector debt and fiscal positions (selected) - Public sector debt 1/: 43.6, 45.9, 41.3, 42.3, 46.3, 44.6, 42.7, 49.1, 57.3, 72.0, 86.5, 100.8, 114.7, 128.4, 156.0, 47.9, 71.3 (series as presented). - Change in public sector debt: -5.8, 2.2, -4.6, 1.0, 3.9, -1.7, -1.9, 6.4, 8.2, 14.7, 14.5, 14.3, 13.9, 13.7, -1.4. - Identified debt-creating flows: -8.0, -4.5, -5.6, -4.0, 4.5, -2.2, -2.8, 6.3, 8.3, 15.0, 15.0, 15.1, 14.8, 14.5, -0.4, -2.4, 7.7. - Primary deficit (selected series): -4.4, -3.7, -3.9, -5.2, 4.0, -0.4, -1.5, 7.4, 9.3, 16.0, 16.4, 16.7, 16.7, 16.7, 2.7, -1.3, 8.7. - Revenue and grants (percent of GDP, selected): 43.2, 42.6, 41.7, 45.7, 45.7, 42.0, 44.4, 34.6, 32.3, 25.1, 25.1, 25.0, 25.0, 25.0, 36.7, 35.3, 33.6. - Grants (percent of GDP, selected): 19.3, 17.8, 18.3, 21.0, 22.9, 18.1, 20.1, 10.5, 8.1, 0.8, 0.8, 0.7, 0.7, 0.7, 0.5, 13.7, 9.5. - PV of public debt-to-GDP ratio (selected): 30.6, 32.0, 36.9, 36.6, 36.1, 39.0, 43.3, 51.2, 58.9, 66.8, 75.2, 83.9, 101.8. - Debt service-to-revenue and grants ratio (selected): 6.3, 6.0, 8.7, 7.4, 5.9, 8.2, 13.3, 21.5, 23.6, 35.8, 33.1, 33.4, 36.6, 32.1, 35.3. ### Stress tests and sensitivity analysis (selected findings) - Table 3 and Table 4 present sensitivity analyses for public and PPG external debt indicators, FY2020–2030, including alternative scenarios, bound tests, and tailored tests. - Tailored tests include: - C2. Natural disaster scenario (selected outcome examples): baseline and stressed indicator values show notable deterioration (e.g., PV of debt-to-GDP and debt service ratios increase under the natural disaster shock). - C1. Combined contingent liabilities scenario indicates substantial increases in debt indicators in stressed years. - Figures illustrate that the most extreme shocks for external PPG and public debt indicators are often combinations of growth, exports, and other flows shocks; natural disaster shocks are among the most severe tailored tests. - Grant element assumed on residual financing (i.e., financing required above baseline) is listed as 45.5 repeated across periods: 45.5, 45.5, 45.5, 45.5, 45.5, 45.5, 45.5, 45.5, 45.5, 45.5, 45.5. ### Implementation priorities and technical actions - Improve debt coverage by reporting contingent debt. - Prepare a medium-term debt strategy reflecting priorities to: - maintain public and external debt at prudent levels; - prioritize concessional/grant financing and refrain from non-concessional borrowing. - Continue to pursue grant financing commitments and additional debt relief from key creditors (including China Eximbank). - Implement revenue administration improvements and spending controls; broaden the tax base, following IMF and World Bank technical assistance recommendations. *Source: Country authorities; and staff estimates and projections.* ### 1990. The size of 3-year adjustment from program inception is found on the horizontal axis; the ### 1tonea2021001 - Statement by Ms. Mahasandana and Mr. Mochtar on Tonga (January 25, 2021) ### Economic impact and outlook - Real GDP is expected to contract by 2.5 percent in FY2020 and decline further by 3.5 percent in FY2021, in contrast to the pre-crisis growth projection of 3.5 percent. - Services sector, including tourism and related segments, are severely affected by border closures and damages from TC Harold. - Lower remittance flows are expected due to economic weakness in source remitting countries, though remittances have shown relative resilience so far. - Reallocation of workers from the seasonal worker program (SWP) and tourism to construction and agriculture, and promotion of local tourism, have helped support employment and growth. ### Fiscal position, financing needs, and debt sustainability - The weak outlook has given rise to sizable government spending and financing needs. - Authorities request access to the IMF’s Rapid Credit Facility (RCF) for the first time; the RCF disbursement is equivalent to 50 percent of quota (SDR 6.9 million). - Higher COVID-19 and cyclone-related spending in FY2020 were largely financed by reallocation of fiscal resources, donor support and drawdown of emergency and reserve funds. - A fiscal deficit equivalent to 4.8 percent of GDP is projected for FY2021, after successive fiscal surpluses since FY2016. - Debt is already at high risk of distress; debt service obligations are expected to increase significantly in FY2024. - Authorities’ actions on debt: request for debt relief in 2020 under the G20 DSSI was approved by its major creditor; a further request for debt relief in 2021 is being sought. Authorities are actively seeking new grant financing and developing a new medium-term debt strategy. ### External stability and reserves - Annual headline inflation declined to -0.8 percent in November 2020 and is expected to remain low. - Tonga’s international reserves increased to 9.9 months of import cover as of end-November 2020 due to government receipts from development partners and higher remittances. - Anticipated external financing gap in the near term is significant, stemming from projected lower tourism and remittance inflows even as import demand rises for COVID-19 response and post-cyclone reconstruction. - Large external debt payments commence in FY2024, increasing medium-term external vulnerabilities and underscoring the need for Fund and development partner support to maintain adequate international reserves and support the exchange rate peg. ### Policy responses and public finances - Authorities prioritized population safety and livelihoods through an economic and social stimulus package approved in April 2020, focusing on upgrading healthcare capacity and supporting hard-hit businesses and households. - Complementary measures: income tax deferrals, duty relief on a case-by-case basis, voluntary access to retirement benefits, loan moratoriums and restructuring by banks. - Tonga signed the COVAX Advanced Market Commitment on 8th January 2021 and is in discussions with bilateral donors and development partners to finance vaccine purchase and distribution; the Ministry of Health is finalizing the vaccine distribution plan. - Authorities remain committed to broadening the tax base and improving spending efficiency, with Fund technical assistance on reviews of tax exemptions (including electricity tariff to incorporate contribution of renewal energy), improving the process for granting tax exemptions, improving tax compliance and administration, and reducing tax arrears. - Review of property fees is underway; efforts to better prioritize health and infrastructure spending and address wage bill overruns will continue. - A review of fiscal anchors on wages, domestic revenues and external debt with Fund technical assistance is planned. - Enhancements to cash management will aim to replenish emergency funds drawn for pandemic and cyclone spending. ### Social protection, governance, and public financial management - A national rapid assessment of economic and social impact of COVID-19 was conducted with ADB technical assistance to inform phasing out of stimulus measures and extension of social protection systems. - Authorities committed to strengthening governance, accountability and transparency in government operations, including auditing and publication of pandemic-related spending and procurement documents. - A new PFM roadmap has been completed to support budget control and fiscal management. ### Monetary policy and financial sector measures - Accommodative monetary policy will be maintained; NRBT will monitor developments and stand ready to provide liquidity support, including reducing the statutory reserve deposit (SRD) requirement if necessary. - Authorities agree on enhancing monetary policy transmission through improved communication and liquidity management. - Further assistance is needed for developing the domestic debt market. - Banking system remains sound with profitable and well capitalized banks and adequately provisioned NPLs; NRBT remains vigilant against credit risk deterioration. - Efforts to extend NRBT supervision to non-bank financial institutions, strengthen insurance and pension fund supervision, and enhance solvency stress testing and macroprudential tools are under way with forthcoming IMF technical assistance. - Improvements planned for credit environment: strengthening credit bureau operations and enhancing efficiency of land lease administration. ### AML/CFT and correspondent banking risk - Strengthening the AML/CFT regime in line with the ongoing APG mutual evaluation is an important priority to mitigate CBR withdrawal risks. - IMF Legal Department reviewed the AML/CFT law; enforcement improvements and development of a national KYC system are being considered. ### Structural reforms and growth prospects - Authorities acknowledge staff’s assessment of Tonga’s low growth potential given natural endowments and reliance on remittances. - Priority on growing the formal private sector, modernizing land lease administration; substantial reforms (e.g., female land rights) would take time. - SWP is viewed as key to addressing unemployment, including youth and women; complementing reintegration into higher value-added activities is planned. - Continued efforts to improve skilled labor supply via TVET programs, advance legal and structural reforms to promote business formation, and review the National Infrastructure Investment Plan (NIIP). - Development partners’ support welcomed for national plans and sectoral strategies to meet the SDGs, building on the Tonga Strategic Development Framework 2015-2025 (TSDF II). - Authorities view remittances as supported by strong family ties and culture but agree structural reforms to diversify the economy are necessary for sustainable long-term growth. ### Conclusions and requests - Authorities remain committed to prudent economic policies to address the pandemic, support a strong recovery, safeguard macroeconomic stability, and promote sustainable and inclusive growth. - Continued policy advice and technical assistance from the Fund (including PFTAC) and development partners is welcomed. - Sustained international community support, including from the Fund, is crucial to enhance Tonga’s economic and financial resiliency in the medium- and longer-term. *Statement by Ms. Mahasandana, Executive Director, and Mr. Mochtar, Alternate Executive Director, on Tonga, January 25, 2021.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1tonea2021001.pdf_