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### Outlook and risks
- Real GDP growth: 2.4 percent in FY2025, mostly led by continued strength in domestic demand including large public investment projects (such as the Funga’uta Lagoon Bridge and the Nuku’alofa port upgrade) and a rebound in agricultural output as the effects of El Nino dissipate.
- Medium-term growth: long-term growth projected at 1.2 percent, reflecting exposure to increasingly frequent natural disasters, persistent loss of workers to emigration, and limited economies of scale due to geographical barriers.
- Balance of risks: tilted to the downside. Specific downside risks include:
  - A global slowdown could reduce tourism receipts and remittances.
  - Rising vulnerabilities in the banking sector, even though localized, pose a downside tail risk.
  - Tonga has experienced three major natural disasters since 2018, incurring substantial capital destruction (11 percent of GDP per year on average).
- Near-term baseline: tourism industry on a recovery path, but tourism earnings as a percentage of GDP are not expected to cross above pre-pandemic levels before 2030.
- Inflation outlook: headline inflation expected to remain below the 5 percent reference rate in FY2025 and onward, supported by retrenchment in local food prices and low import prices inflation.

### Fiscal stance, risks, and recommendations
- Current stance: appropriately focused on supporting reconstruction and building resilience in the near term.
- Fiscal risks and debt: high risk of debt distress and sizable financing needs; over the medium term, a credible fiscal consolidation, additional grant financing, and refraining from new non-concessional borrowing are essential to place debt on a downward trajectory while achieving Tonga’s development goals.
- Specific recommendations:
  - Mobilize revenue, including streamlining tax exemptions and strengthening tax administration.
  - Enhance public financial management and spending efficiency.
  - Contain the public sector wage bill.
  - Adhere to the fiscal rule.
- Fiscal balances and related numbers (percent of GDP unless otherwise noted):
  - Revenue: 49.6 (FY2021), 47.3 (FY2022), 53.5 (FY2023), 52.5 (FY2024), 41.5 (FY2025).
  - Grants (of revenue): 23.0 (FY2021), 19.9 (FY2022), 27.6 (FY2023), 26.7 (FY2024), 15.8 (FY2025).
  - Expenditure: 50.6 (FY2021), 48.1 (FY2022), 47.4 (FY2023), 49.0 (FY2024), 49.5 (FY2025).
  - Expense: 42.9 (FY2021), 42.0 (FY2022), 39.6 (FY2023), 37.2 (FY2024), 38.6 (FY2025).
  - Net acquisition of nonfinancial assets: 7.7 (FY2021), 6.1 (FY2022), 7.8 (FY2023), 11.8 (FY2024), 10.9 (FY2025).
  - Primary balance: -0.6 (FY2021), -0.2 (FY2022), 6.7 (FY2023), 3.9 (FY2024), -7.5 (FY2025).
  - Overall balance: -1.0 (FY2021), -0.7 (FY2022), 6.0 (FY2023), 3.5 (FY2024), -8.0 (FY2025).
  - Overall balance (excl. grants): -24.0 (FY2021), -20.7 (FY2022), -21.5 (FY2023), -23.3 (FY2024), -23.7 (FY2025).
  - Public debt (external and domestic): 48.8 (FY2021), 47.5 (FY2022), 43.3 (FY2023), 37.8 (FY2024), 44.0 (FY2025).
  - External debt (of which): 42.3 (FY2021), 41.3 (FY2022), 37.8 (FY2023), 32.3 (FY2024), 38.0 (FY2025).

### Monetary and financial sector policies
- Monetary stance: current monetary policy stance is appropriate; tightening warranted should demand-driven domestic inflation pressures resurface coupled with accelerating bank lending.
- Inflation performance and numbers:
  - Consumer prices (period average): 1.4 (FY2021), 8.5 (FY2022), 10.2 (FY2023), 4.6 (FY2024), 3.2 (FY2025).
  - Consumer prices (end of period): 6.9 (FY2021), 11.3 (FY2022), 7.4 (FY2023), 5.4 (FY2024), 3.0 (FY2025).
  - Headline inflation peaked at 14.1 percent in September 2022; reached 5.4 percent in June 2024; fell to 3 percent in July 2024.
  - Core inflation (IMF calculation): 1.3 percent in July 2024.
- Credit and money aggregates:
  - Broad money (M2): 25.0 (FY2021), 13.4 (FY2022), -0.3 (FY2023), 1.7 (FY2024), 3.6 (FY2025).
  - Domestic credit: -8.2 (FY2021), -3.3 (FY2022), -15.6 (FY2023), 38.5 (FY2024), 6.2 (FY2025).
  - Private sector credit: 1.0 (FY2021), -1.0 (FY2022), 9.0 (FY2023), 6.8 (FY2024), 5.0 (FY2025).
  - Total lending growth: 4.1 percent (y/y) at end-June 2024; households 6.0 percent, business 2.2 percent.
- Reserves and external metrics:
  - Gross official foreign reserves (millions of U.S. dollars): 320.7 (FY2021), 378.5 (FY2022), 388.8 (FY2023), 386.1 (FY2024), 403.9 (FY2025).
  - Reserves (in months of next year's total imports): 11.7 (FY2021), 11.8 (FY2022), 11.2 (FY2023), 10.6 (FY2024), 10.7 (FY2025).
  - Current account balance (in percent of GDP): -6.8 (FY2021), -6.8 (FY2022), -6.6 (FY2023), -7.4 (FY2024), -7.7 (FY2025).
  - Exports of goods, f.o.b.: 16.2 (FY2021), 15.1 (FY2022), 13.1 (FY2023), 12.9 (FY2024), 15.4 (FY2025).
  - Imports of goods, f.o.b.: 215.4 (FY2021), 216.1 (FY2022), 235.4 (FY2023), 257.6 (FY2024), 271.4 (FY2025).

### Banking sector vulnerabilities and policy recommendations
- Banking sector vulnerabilities:
  - Localized vulnerabilities noted; Directors encouraged close monitoring of credit risks and ensuring adequate provisioning for loan losses.
- Supervisory recommendations:
  - Expand supervisory and regulatory frameworks to cover non-bank financial institutions.
  - Expand macroprudential toolkit; conduct regular bank stress tests; strengthen prudential standards and governance.
  - Consider requiring banks to adopt a more conservative provisioning approach and to submit concrete plans for NPL reduction.
- Banking sector soundness and liquidity (key statistics as of June 2024):
  - Capital adequacy: 32.1 percent (above the 15 percent regulatory requirement).
  - Liquid Asset Ratio (LAR): 46.9 percent.
  - Banks’ excess reserves: around 30 percent of GDP.
  - NPL ratio: increased from 7.4 percent in 2023Q1 to 11.2 percent at the end of June 2024.
  - NPL coverage ratio: declined from around 36.3 percent at end-2022 to 11.4 percent by the end of 2023.

### Structural reforms, governance, and capacity development
- Structural priorities:
  - Enhance resilience to climate change and natural disasters.
  - Promote private sector development and reduce fossil fuel dependency with clean energy.
  - Strengthen energy security and lower elevated energy costs.
  - Foster private sector development; enhance anti-corruption and governance frameworks.
- Governance and AML/CFT:
  - Directors welcomed appointment of the first anti-corruption commissioner and authorities’ commitment to continue strengthening the AML/CFT framework to reduce risk of losing correspondent banking relationships.
- Capacity development (CD):
  - Tonga is one of the largest recipients of IMF CD resources in the region.
  - Recent IMF technical assistance areas: monetary policy operations, PFM, tax policy, revenue administration, macroeconomic and stress-testing frameworks, GDP nowcasting, AML/CFT and financial stability frameworks.
  - Further support needed to address governance challenges and data shortcomings, particularly in external, fiscal, national accounts and monetary and financial statistics.
  - Fund providing TA on amending the central bank act following safeguards assessment in December 2021.

### Key recent developments and indicators
- Real GDP: -1.3 (FY2021), 0.0 (FY2022), 2.0 (FY2023), 1.8 (FY2024), 2.4 (FY2025).
- Tourism receipts (percent of GDP): 9.1 (FY2021), 9.9 (FY2022), 43.9 (FY2023), 49.9 (FY2024), 55.0 (FY2025).
- Total remittances (millions of U.S. dollars): 220.8 (FY2021), 215.9 (FY2022), 256.0 (FY2023), 263.1 (FY2024), 274.2 (FY2025).
  - As percent of GDP: 48.2 (FY2021), 45.4 (FY2022), 49.2 (FY2023), 48.2 (FY2024), 48.0 (FY2025).
- Compensation of overseas workers: 41.3 (FY2021), 35.3 (FY2022), 55.3 (FY2023), 59.2 (FY2024), 62.3 (FY2025).
- Personal remittances: 179.6 (FY2021), 180.6 (FY2022), 200.6 (FY2023), 203.9 (FY2024), 211.9 (FY2025).
- Official grants: 10.5 (FY2021), 24.6 (FY2022), 22.9 (FY2023), 29.1 (FY2024), 27.6 (FY2025).
- Capital account balance: 69.1 (FY2021), 73.2 (FY2022), 66.1 (FY2023), 59.2 (FY2024), 17.2 (FY2025).
- Financial account balance: 0.9 (FY2021), 29.5 (FY2022), 17.6 (FY2023), -17.5 (FY2024), 44.7 (FY2025).
- Nominal GDP (millions of US$): 458.6 (FY2021), 475.4 (FY2022), 520.3 (FY2023), 545.4 (FY2024), 571.1 (FY2025).
- Population (2021): 100 thousands.
- Major exports: root crops, vegetables, shellfish, fish.

### Medium-term growth prospects, external position, and reserve adequacy
- Long-term growth projected at 1.2 percent.
- Current account deficit expected to narrow only slowly over the medium-term, reflecting continued recovery of tourism, heavy import dependence, and substantial infrastructure needs.
- FX reserve coverage projected to remain adequate at about 10¾ -11 months of imports, above the NRBT’s target of 7½ months, supported by external financing.
- External position: FY2024 external position assessed as broadly in line with fundamentals (EBA-lite results); CA-Actual -7.4 (FY2024), Adjusted CA -8.0, CA Norm -8.0, CA Gap 0.0.
- Reserve adequacy (FY2024):
  - Actual Reserves (months of prospective imports): 10.6.
  - Optimal levels: 4.6 (standard shock probability), 7.3 (higher shock probability), 8.0 (taking into account debt repayment).
  - Broad Money coverage: 113%.

### Debt sustainability, shock scenarios, and fiscal consolidation path
- Tonga assessed as being at high risk of debt distress.
- Without additional grant commitments:
  - PV of external and public debt-to-GDP ratios projected to keep rising and both cross the 55 percent threshold and the 70 percent benchmark in FY2034.
  - Debt obligations largely external, with over half of the external debt to China Exim Bank.
  - Debt repayments surged to 3.5 percent of GDP in FY2024, mainly to Exim Bank, and remain elevated at over 3.0 percent of GDP until FY2027.
- Illustrative fiscal adjustment scenario (FY2026–FY2034) with domestic measures and modest additional grants:
  - PV of public debt-to-GDP would stabilize below the 70 percent benchmark with a buffer, even under natural disaster or multi-year growth shock.
  - PV of external debt-to-GDP would stabilize below the 55 percent threshold under this scenario.
  - Ratio of employee compensation to domestic revenues projected to fall below the 53 percent threshold starting from 2026 under the adjustment scenario.
- Quantified domestic consolidation needed (FY2026–FY2034, in percent of GDP): 1.3, 1.9, 2.2, 2.5, 2.6, 2.6, 3.1, 3.8, 4.5.
- Contributions to consolidation (FY2026–FY2034, in percent of GDP):
  - From tax revenue (total): 0.8, 0.8, 0.8, 1.1, 1.2, 1.2, 1.7, 2.3, 2.7.
  - Improved consumption tax (component): 0.3, 0.3, 0.3, 0.3, 0.4, 0.4, 0.4, 0.5, 0.6.
  - Less tax exemptions (component): 0.5, 0.5, 0.5, 0.8, 0.8, 0.8, 1.3, 1.8, 2.1.
  - Contribution from current spending reductions and lower public sector wage bill shown across projection years (see table for year-by-year values).
  - Additional Grants (FY2026–FY2034): 0.0, 0.0, 0.0, 1.3, 2.0, 2.8, 3.5, 4.5, 5.5.

### Debt stock, creditor composition, and repayment schedule
- Total public and publicly guaranteed (PPG) external debt: USD189 million (about 38 percent of GDP) as of end-June 2023, accounting for 87 percent of total public debt.
- Outstanding debt to all multilateral creditors: USD88 million (about 18 percent of GDP), or about 46 percent of the total external debt stock.
- Single largest creditor: Export-Import Bank of China (China Exim Bank), which accounts for 54 percent of total external debt stock; loans from China Exim Bank are denominated in Chinese renminbi.
- Repayment schedule (selected rows, percent of GDP):
  - Total external debt service: FY2024 3.5, FY2025 3.3, FY2026 3.1, FY2027 3.0, FY2028 2.7, FY2029 1.8, FY2030 0.9, FY2031 0.3, FY2032 0.3, FY2033 0.3, FY2034 0.3.
  - Bilateral (EXIM Bank of China): FY2024 3.0, FY2025 2.8, FY2026 2.5, FY2027 2.4, FY2028 2.2, FY2029 1.3, FY2030 0.5, FY2031 0.0, FY2032 0.0, FY2033 0.0, FY2034 0.0.
  - Average annual payments to China Exim Bank in FY2024–29: about 2.4 percent of GDP.
- Public domestic debt: USD29 million (about 5.5 percent of GDP) at end-June 2023, accounting for 13 percent of total public debt.

### Risk matrix and prioritized policy responses
- Key risks and policy guidance (selected):
  - Extreme climate events (Likelihood: High; Expected impact: High): Prioritize ex-ante adaptation investment and ex-post support; strengthen monitoring of banking asset quality; strengthen fiscal buffers by accelerating revenue mobilization reforms.
  - Acceleration of outward migration (Likelihood: High; Expected impact: Medium): Create economic opportunities via private sector development, attract FDI, diversify economy; enhance education and skill development.
  - Partial withdrawal of correspondent banking relationships (CBRs) (Likelihood: Medium; Expected impact: High): Strengthen AML/CFT framework and implementation; pass the MLPCA and Regulation amendments Bill; consider regional CBR Roadmap.
  - Further increase in non-performing loans (NPLs) (Likelihood: Medium; Expected impact: Medium-High): NRBT should closely monitor asset quality and strengthen bank oversight; request NPL reduction plans with minimum provisioning targets.

### Data gaps, adequacy, and capacity development priorities
- Data Adequacy Assessment Rating: C.
- Sectoral median ratings: C B C C C D C.
- Significant data gaps and shortcomings:
  - Labor market data (including unemployment, employment, labor force participation by gender and age).
  - Delays in External Sector data, particularly IIP.
  - Need for more frequent GDP releases including expenditure components.
  - Inconsistencies between grants recorded in BoP and Government Finance Statistics.
  - Monetary and Financial Statistics improvements needed for NBFI data.
- Corrective actions and CD priorities:
  - Enhance training and ensure adequate staffing.
  - CD priorities: GDP, GFS, External sector (BOP and IIP), Monetary and financial sectors.
  - Ongoing CD: resumption of national accounts compilation with PFTAC support; national accounts publication expected to return to former schedule by FY 2025.
- Table of data provision notes (selected timeliness markers):
  - Exchange Rates: Date of Latest Observation: 6/2024; Date Received: 8/2024.
  - Consumer Price Index: Date of Latest Observation: 7/2024; Date Received: 9/2024.
  - Revenue, Expenditure, Balance and Composition of Financing ‒ Central Government: Date of Latest Observation: 2022/23; Date Received: 5/2024.

### Authorities’ views and policy intentions (summarized)
- Authorities broadly agreed with staff’s assessment and were relatively more optimistic about the near-term outlook:
  - Authorities’ GDP growth projections for this and next fiscal year range between 2.5 and 3 percent.
  - NRBT projects inflation to be below 5 percent by FY2025, with headline inflation expected between 2 to 4 percent.
  - Concerns over potential spikes in domestic food prices affecting inflation and cost of living.
  - Authorities consider loss of workers to emigration and recurrent natural disasters as major risks.
- Authorities’ policy intentions:
  - Continue prioritizing reconstruction and social protection in the near term while advancing fiscal reforms.
  - FY2025 budget includes increasing allowances for the elderly by lowering coverage age from 70 to 67 years.
  - Plan to introduce performance-based assessments in FY2025 to improve efficiency.
  - Committed to revenue mobilization measures, streamlining tax exemptions for tourism and agriculture, and adhering to the fiscal rule.
  - Committed to securing new grant financing to keep debt on a sustainable path while meeting climate resilience and development goals.

### Conclusion — policy priorities and institutional reforms
- Short-term: maintain expansionary fiscal stance to accelerate reconstruction and protect vulnerable groups.
- Medium-term: gradual and credible fiscal consolidation combined with additional grant financing to put debt on a firm downward path and build fiscal buffers.
- Monetary policy: maintain accommodative stance while ready to tighten if demand-driven inflation resurfaces; consider strengthening NRBT Act operational clarity and use of policy rate.
- Financial sector: maintain strong capitalization and ample liquidity; proactively address asset quality risks and broaden NRBT’s remit to cover NBFIs.
- Fiscal rules and governance:
  - Fiscal anchors: Compensation of employees <53 (percent of domestic revenue); Domestic revenue >22 (percent of GDP); External debt <50 (percent of GDP).
  - Recommendations: clarify thresholds, strengthen enforcement and escape clauses, improve transparency and PFM, consider a fiscal council, and use MTFF to set wage limits.
- Structural reforms: enforce Building Codes; incentivize relocation from high-risk areas; boost private sector development, digitalization, education and training; strengthen AML/CFT and anti-corruption measures.
- Data: allocate ample resources to ensure timely and reliable macroeconomic statistics for policymaking and surveillance.

*Source: TONGA — STAFF REPORT FOR THE 2024 ARTICLE IV CONSULTATION (data and text as provided).*

### 2.4 percent in FY2025, mostly led by continued strength in domestic demand including

### 2.4 percent in FY2025, mostly led by continued strength in domestic demand including

### Outlook and risks
- Real GDP growth: 2.4 percent in FY2025, mostly led by continued strength in domestic demand including large public investment projects (such as the Funga’uta Lagoon Bridge and the Nuku’alofa port upgrade) and a rebound in agricultural output as the effects of El Nino dissipate.
- Medium-term growth: long-term growth projected at 1.2 percent, reflecting exposure to increasingly frequent natural disasters, persistent loss of workers to emigration, and limited economies of scale due to geographical barriers.
- Balance of risks: tilted to the downside. Specific downside risks include:
  - A global slowdown could reduce tourism receipts and remittances.
  - Rising vulnerabilities in the banking sector, even though localized, pose a downside tail risk.
  - Tonga has experienced three major natural disasters since 2018, incurring substantial capital destruction (11 percent of GDP per year on average).
- Near-term baseline: tourism industry on a recovery path, but tourism earnings as a percentage of GDP are not expected to cross above pre-pandemic levels before 2030.
- Inflation outlook: headline inflation expected to remain below the 5 percent reference rate in FY2025 and onward, supported by retrenchment in local food prices and low import prices inflation.

### Fiscal stance and recommendations
- Current stance: appropriately focused on supporting reconstruction and building resilience in the near term.
- Fiscal risks and debt: high risk of debt distress and sizable financing needs; over the medium term, a credible fiscal consolidation, additional grant financing, and refraining from new non-concessional borrowing are essential to place debt on a downward trajectory while achieving Tonga’s development goals.
- Specific recommendations:
  - Mobilize revenue, including streamlining tax exemptions and strengthening tax administration.
  - Enhance public financial management and spending efficiency.
  - Contain the public sector wage bill.
  - Adhere to the fiscal rule.
- Fiscal balances and related numbers (percent of GDP unless otherwise noted):
  - Revenue: 49.6 (FY2021), 47.3 (FY2022), 53.5 (FY2023), 52.5 (FY2024), 41.5 (FY2025).
  - Grants (of revenue): 23.0 (FY2021), 19.9 (FY2022), 27.6 (FY2023), 26.7 (FY2024), 15.8 (FY2025).
  - Expenditure: 50.6 (FY2021), 48.1 (FY2022), 47.4 (FY2023), 49.0 (FY2024), 49.5 (FY2025).
  - Expense: 42.9 (FY2021), 42.0 (FY2022), 39.6 (FY2023), 37.2 (FY2024), 38.6 (FY2025).
  - Net acquisition of nonfinancial assets: 7.7 (FY2021), 6.1 (FY2022), 7.8 (FY2023), 11.8 (FY2024), 10.9 (FY2025).
  - Primary balance: -0.6 (FY2021), -0.2 (FY2022), 6.7 (FY2023), 3.9 (FY2024), -7.5 (FY2025).
  - Overall balance: -1.0 (FY2021), -0.7 (FY2022), 6.0 (FY2023), 3.5 (FY2024), -8.0 (FY2025).
  - Overall balance (excl. grants): -24.0 (FY2021), -20.7 (FY2022), -21.5 (FY2023), -23.3 (FY2024), -23.7 (FY2025).
  - Public debt (external and domestic): 48.8 (FY2021), 47.5 (FY2022), 43.3 (FY2023), 37.8 (FY2024), 44.0 (FY2025).
  - External debt (of which): 42.3 (FY2021), 41.3 (FY2022), 37.8 (FY2023), 32.3 (FY2024), 38.0 (FY2025).

### Monetary and financial sector policies
- Monetary stance: current monetary policy stance is appropriate; tightening warranted should demand-driven domestic inflation pressures resurface coupled with accelerating bank lending.
- Inflation performance and numbers:
  - Consumer prices (period average): 1.4 (FY2021), 8.5 (FY2022), 10.2 (FY2023), 4.6 (FY2024), 3.2 (FY2025).
  - Consumer prices (end of period): 6.9 (FY2021), 11.3 (FY2022), 7.4 (FY2023), 5.4 (FY2024), 3.0 (FY2025).
  - Headline inflation peaked at 14.1 percent in September 2022; reached 5.4 percent in June 2024; fell to 3 percent in July 2024.
  - Core inflation (IMF calculation): 1.3 percent in July 2024.
- Banking sector vulnerabilities:
  - Localized vulnerabilities noted; Directors encouraged close monitoring of credit risks and ensuring adequate provisioning for loan losses.
  - Recommendations: expand supervisory and regulatory frameworks to cover non-bank financial institutions; expand macroprudential toolkit; conduct regular bank stress tests; strengthen prudential standards and governance.
- Credit and money aggregates:
  - Broad money (M2): 25.0 (FY2021), 13.4 (FY2022), -0.3 (FY2023), 1.7 (FY2024), 3.6 (FY2025).
  - Domestic credit: -8.2 (FY2021), -3.3 (FY2022), -15.6 (FY2023), 38.5 (FY2024), 6.2 (FY2025).
  - Private sector credit: 1.0 (FY2021), -1.0 (FY2022), 9.0 (FY2023), 6.8 (FY2024), 5.0 (FY2025).
  - Total lending growth: 4.1 percent (y/y) at end-June 2024; households 6.0 percent, business 2.2 percent.
- Reserves and external metrics:
  - Gross official foreign reserves (millions of U.S. dollars): 320.7 (FY2021), 378.5 (FY2022), 388.8 (FY2023), 386.1 (FY2024), 403.9 (FY2025).
  - Reserves (in months of next year's total imports): 11.7 (FY2021), 11.8 (FY2022), 11.2 (FY2023), 10.6 (FY2024), 10.7 (FY2025).
  - Current account balance (in percent of GDP): -6.8 (FY2021), -6.8 (FY2022), -6.6 (FY2023), -7.4 (FY2024), -7.7 (FY2025).
  - Exports of goods, f.o.b.: 16.2 (FY2021), 15.1 (FY2022), 13.1 (FY2023), 12.9 (FY2024), 15.4 (FY2025).
  - Imports of goods, f.o.b.: 215.4 (FY2021), 216.1 (FY2022), 235.4 (FY2023), 257.6 (FY2024), 271.4 (FY2025).

### Structural reforms and capacity development
- Structural priorities: enhance resilience to climate change and natural disasters; promote private sector development; reduce fossil fuel dependency with clean energy; strengthen energy security and lower elevated energy costs; foster private sector development; enhance anti-corruption and governance frameworks.
- Governance and AML/CFT:
  - Directors welcomed appointment of the first anti-corruption commissioner and authorities’ commitment to continue strengthening the AML/CFT framework to reduce risk of losing correspondent banking relationships.
- Capacity development (CD):
  - Tonga is one of the largest recipients of IMF CD resources in the region.
  - Recent IMF technical assistance areas: monetary policy operations, PFM, tax policy, revenue administration, macroeconomic and stress-testing frameworks, GDP nowcasting, AML/CFT and financial stability frameworks.
  - Further support needed to address governance challenges and data shortcomings, particularly in external, fiscal, national accounts and monetary and financial statistics.
  - Fund providing TA on amending the central bank act following safeguards assessment in December 2021.

### Key recent developments and indicators
- Real GDP: -1.3 (FY2021), 0.0 (FY2022), 2.0 (FY2023), 1.8 (FY2024), 2.4 (FY2025).
- Tourism receipts (percent of GDP): 9.1 (FY2021), 9.9 (FY2022), 43.9 (FY2023), 49.9 (FY2024), 55.0 (FY2025).
- Total remittances (millions of U.S. dollars): 220.8 (FY2021), 215.9 (FY2022), 256.0 (FY2023), 263.1 (FY2024), 274.2 (FY2025).
  - As percent of GDP: 48.2 (FY2021), 45.4 (FY2022), 49.2 (FY2023), 48.2 (FY2024), 48.0 (FY2025).
- Compensation of overseas workers: 41.3 (FY2021), 35.3 (FY2022), 55.3 (FY2023), 59.2 (FY2024), 62.3 (FY2025).
- Personal remittances: 179.6 (FY2021), 180.6 (FY2022), 200.6 (FY2023), 203.9 (FY2024), 211.9 (FY2025).
- Official grants: 10.5 (FY2021), 24.6 (FY2022), 22.9 (FY2023), 29.1 (FY2024), 27.6 (FY2025).
- Capital account balance: 69.1 (FY2021), 73.2 (FY2022), 66.1 (FY2023), 59.2 (FY2024), 17.2 (FY2025).
- Financial account balance: 0.9 (FY2021), 29.5 (FY2022), 17.6 (FY2023), -17.5 (FY2024), 44.7 (FY2025).
- Nominal GDP (millions of US$): 458.6 (FY2021), 475.4 (FY2022), 520.3 (FY2023), 545.4 (FY2024), 571.1 (FY2025).
- Population (2021): 100 thousands.
- Major exports: root crops, vegetables, shellfish, fish.

*Source: TONGA — STAFF REPORT FOR THE 2024 ARTICLE IV CONSULTATION (data and text as provided).*

### 9. Medium-term growth prospects remain uneven. Tonga’s long-term growth is projected at

### Medium-term growth prospects remain uneven. Tonga’s long-term growth is projected at

### Growth outlook and risks
- Long-term growth projected at 1.2 percent.
- Current account deficit expected to narrow only slowly over the medium-term, reflecting:
  - continued recovery of tourism notwithstanding the normalization of remittances,
  - heavy import dependence,
  - substantial infrastructure needs.
- FX reserve coverage projected to remain adequate at about 10¾ -11 months of imports, above the NRBT’s target of 7½ months, supported by external financing.
- Balance of risks tilted to the downside:
  - Frequent natural disasters could increase demands on public resources and decrease asset quality in the banking sector.
  - Further loss of correspondent banking relationships (CBRs) due to AML/CFT-related weaknesses could disrupt transfers and remittance flows.
  - Faster outflows of Tonga workers would tilt GDP growth risks to the downside and domestic inflation risks to the upside.
  - A global slowdown would reduce tourism receipts and remittances.
- Upside risks: faster-than-expected tourism recovery and stronger-than-expected grants.

### Debt sustainability and shock scenarios
- Tonga assessed as being at high risk of debt distress (DSA Annex).
- Without additional grant commitments to staff’s baseline projection:
  - PV of external and public debt-to-GDP ratios projected to keep rising and both cross the 55 percent threshold and the 70 percent benchmark in FY2034.
  - Debt obligations largely external, with over half of the external debt to China Exim Bank.
  - Debt repayments surged to 3.5 percent of GDP in FY2024, mainly to Exim Bank, and remain elevated at over 3.0 percent of GDP until FY2027.
- Government’s plan to refrain from new non-concessional borrowing would help reduce risk of debt distress.
- Illustrative fiscal adjustment scenario (FY2026–FY2034) with domestic measures and modest additional grants:
  - PV of public debt-to-GDP would stabilize below the 70 percent benchmark with a buffer, even under natural disaster or multi-year growth shock.
  - PV of external debt-to-GDP would stabilize below the 55 percent threshold under this scenario.
  - Ratio of employee compensation to domestic revenues projected to fall below the 53 percent threshold starting from 2026 under the adjustment scenario.

### Fiscal position, dynamics, and recommended consolidation
- FY2024 overall fiscal balance expected to remain in surplus at 3.5 percent of GDP, despite high reconstruction-related expenditures, due to record-high grant inflows and stronger-than-expected consumption tax and income tax revenues.
- IMF staff projects the fiscal balance to revert to a deficit of 8.0 percent of GDP in FY2025, assuming external grants return to their historical trend while public reconstruction expenditures remain strong.
- Fiscal impulse:
  - Excluding grants, FY2024 fiscal impulse is expansionary, about 2.0 percent of GDP.
  - Expected to moderate to mildly expansionary in FY2025, about 0.5 percent of GDP.
- Public sector wage bill dynamics:
  - Public sector wage bill expected to cross the 53 percent limit as share of domestic revenues.
  - Driven by a 15 percent anticipated increase in public sector wage bill in FY2025, resulting from a 5 percent cost of living adjustment and filling existing vacancies.
- Fiscal consolidation strategy (three-prong approach):
  - Domestic revenue mobilization, including a gradual increase in tax revenues.
  - Enhancing spending efficiency and restraining public wage bill.
  - Securing additional grants from development partners.
- Quantified consolidation path:
  - Fiscal consolidation envisaged for FY2026 is 1.3 percent of GDP, increasing to 4.5 percent by FY2034.
- Specific measures and estimates:
  - Removing tax-inefficient exemptions estimated at 13 percent of GDP (Liu and others 2019), without increasing statutory rates.
  - Consumption tax rate is 15 percent in Tonga.
  - IMF (SR, 2023) reference: potential revenue impact from reform about 6.2 percent of GDP (for reference).
  - IMF (SR, 2021) reference: an additional 2.5 percent of GDP in tax revenues could be collected by removing various tax exemptions (for reference).
  - Additional grants discussion:
    - Footnote: The additional grants aim to maintain the level above 8.5 percent of GDP, close to the historical average.
    - Table footnote: The additional grants are to maintain the grants above 10 percent of GDP.
- Illustrative costing table highlights (selected items, in percent of GDP):
  - Domestic consolidation needed (FY2026–FY2034): 1.3, 1.9, 2.2, 2.5, 2.6, 2.6, 3.1, 3.8, 4.5.
  - Contribution from tax revenue (FY2026–FY2034): 0.8, 0.8, 0.8, 1.1, 1.2, 1.2, 1.7, 2.3, 2.7.
  - Improved consumption tax (component): 0.3, 0.3, 0.3, 0.3, 0.4, 0.4, 0.4, 0.5, 0.6.
  - Less tax exemptions (component): 0.5, 0.5, 0.5, 0.8, 0.8, 0.8, 1.3, 1.8, 2.1.
  - Contribution from current spending reductions and lower public sector wage bill shown across projection years (see table for year-by-year values).
  - Additional Grants (FY2026–FY2034): 0.0, 0.0, 0.0, 1.3, 2.0, 2.8, 3.5, 4.5, 5.5.

### Policy discussions and recommendations
- Short-term: current expansionary fiscal stance appropriate to accelerate reconstruction and support resilience.
- Medium-term: gradual and credible fiscal consolidation and additional grant financing warranted to put debt on a firm downward path and build fiscal buffers.
- Fiscal policy priorities:
  - Boost domestic revenue mobilization.
  - Limit spending unrelated to reconstruction, including normalizing public sector wage bill.
  - Remove tax-inefficient exemptions and improve tax administration and compliance.
  - Secure additional grants to meet development and climate resilience needs while minimizing debt distress risk.
- Structural and governance reforms:
  - Continue Medium-term Fiscal Framework to strengthen fiscal planning and discipline.
  - Passage and implementation of the Public Financial Management (PFM) Act expected to be presented to parliament before year-end.
  - Continue rollout of Electronic Sales Register System and upgrade revenue management systems.
  - Publish pandemic-related procurement contracts with beneficial ownership information as committed under the IMF’s RCF; expand publication of procurement award information.
- Fiscal adjustment scenario is intended to stabilize debt even under shocks and to reduce the ratio of employee compensation to domestic revenues below the 53 percent ceiling from 2026.

### Monetary policy, NRBT, and exchange rate
- Monetary stance:
  - Current monetary policy stance appropriately accommodative as inflation has stabilized below the 5 percent reference rate.
  - NRBT increased the statutory reserve deposit (SRD) ratio from 10 percent to 15 percent in February 2023 while keeping the policy rate (rate on excess bank reserves) unchanged at zero percent.
  - Impact on aggregate demand and bank lending limited due to abundant excess liquidity.
  - If demand-driven domestic inflation pressures resurface, including accelerating bank lending, tightening warranted, including raising the policy rate.
- NRBT Act amendments: opportunity to strengthen monetary policy framework with IMF TA:
  - Redefine preferred inflation measure by focusing on a core measure excluding volatile energy and food prices.
  - More proactive use of the policy rate and improved communication strategy, such as publishing regular board meeting dates.
  - Clarify operational guidelines for transfer of profits, coverage of losses, and recapitalization, consistent with the 2021 IMF safeguards assessment and TA recommendations.
  - Continue implementing safeguards recommendations, including establishing internal audit capacity, business continuity plan, and cybersecurity policy.
  - Staff advised against amendments that could normalize open-ended quasi-fiscal operations, undermine central bank operational independence, or impair NRBT’s financial autonomy.
- Exchange rate developments:
  - Between July 2023 and June 2024, the nominal effective exchange rate (NEER) increased by 2.2 percent compared to the previous year following the USD appreciation.
  - REER increased by 2.8 percent over the same period.
  - TOP appreciated against major trading partner currencies (AUD, NZD, FJD, JPY, and CNY), partially offsetting the impact of higher import prices on domestic inflation.

### Authorities’ views (summarized)
- Authorities broadly agreed with staff’s assessment and were relatively more optimistic about the near-term outlook:
  - Authorities’ GDP growth projections for this and next fiscal year range between 2.5 and 3 percent, slightly higher than staff.
  - Growth expected led by continued strength in domestic demand due to large upcoming public investment projects and stronger tertiary sector contribution (including hosting the 53rd Pacific Islands Forum Leaders Meeting in August 2024).
  - NRBT projects inflation to be below 5 percent by FY2025, with headline inflation expected between 2 to 4 percent.
  - Concerns over potential spikes in domestic food prices affecting inflation and cost of living.
  - Authorities consider loss of workers to emigration and recurrent natural disasters as major risks to medium- and long-term growth.
- Authorities’ policy intentions:
  - Continue prioritizing reconstruction and social protection in the near term while advancing fiscal reforms.
  - FY2025 budget includes increasing allowances for the elderly by lowering coverage age from 70 to 67 years.
  - Plan to introduce performance-based assessments in FY2025 to improve efficiency.
  - Committed to revenue mobilization measures, streamlining tax exemptions for tourism and agriculture, and adhering to the fiscal rule.
  - Committed to securing new grant financing to keep debt on a sustainable path while meeting climate resilience and development goals.

*Source: IMF staff report text provided in the content unit.*

### 23. Like staff, the authorities view the current monetary stance as appropriately

### 23. Like staff, the authorities view the current monetary stance as appropriately

### Monetary policy stance and implementation
- The NRBT plans to maintain its accommodative monetary policy stance to nurture the ongoing post-pandemic recovery.
- The NRBT will tighten policy if excess-demand driven inflationary pressures re-emerge.
- Given the limited effectiveness of the monetary tools available, in the event of a significant inflation surge, the NRBT advocates complementing monetary tightening with fiscal tightening.
- The NRBT plans to continue improving the effectiveness of monetary policy transmission, including through improved liquidity management and communication.
- Although banking sector liquidity levels remain elevated so far, the NRBT will consider lowering the SRD rate in case liquidity needs arise.
- Foreign currency reserves remain at adequate levels owing to continued inflows of grants and remittances, which is crucial given Tonga’s vulnerability to natural disasters, external shocks, high import dependence, and external debt repayments.

### Targeted lending support and NRBT Act amendments
- The authorities propose amendments to the NRBT Act to introduce two NRBT facilities to subsidize bank lending in sectors relevant for Tonga’s economic growth, such as education and tourism.
- The authorities broadly concurred with staff on the potential amendments to the NRBT Act and are open to incorporating recommendations from ongoing IMF TA that could address these proposed amendments.

### Banking sector soundness and liquidity (key statistics as of June 2024)
- Capital adequacy: 32.1 percent (above the 15 percent regulatory requirement).
- Liquid Asset Ratio (LAR): 46.9 percent.
- Banks’ excess reserves: around 30 percent of GDP.
- NPL ratio: increased from 7.4 percent in 2023Q1 to 11.2 percent at the end of June 2024.
- NPL coverage ratio: declined from around 36.3 percent at end-2022 to 11.4 percent by the end of 2023.

### Asset quality risks and supervisory recommendations
- The increase in the NPL ratio was mostly driven by business loans in the transport sector; some NPLs may reflect lingering effects of the HT-HH disaster and COVID–19.
- Systemic risk has increased but remains largely contained due to major banks being well capitalized and subsidiaries of sizeable foreign financial institutions.
- Recommended reforms and actions:
  - Continue regular stress tests to ensure banks maintain sufficient capital.
  - Strengthen prudential standards and regulations (e.g., for credit unions and those related to provisioning).
  - Avoid frequent staff turnover.
  - Expand scope and increase frequency of relevant data collection to enhance risk-based supervision.
  - Broaden NRBT’s regulatory and supervisory remit to cover NBFIs, including the retirement funds.
  - Issue domestic government bonds to promote domestic interbank markets and financial deepening.
  - Consider requiring banks to adopt a more conservative provisioning approach and to submit concrete plans for NPL reduction.

### Financial inclusion and digital finance initiatives
- PSDI proposed support for a feasibility study to evaluate establishment of a Credit Registry to improve credit monitoring for businesses and households.
- NRBT unveiled the National Financial Inclusion Strategy (NFIS) for 2023-2027 in November 2023.
- NRBT conducted inaugural in-country training in March 2024 with AFI on Responsible Digital Financial Services, Product Innovation and Delivery, and Inclusive Green Finance; working groups and TORs are being established.

### AML/CFT and supervisory capacity building
- The forthcoming Money Laundering and Proceeds of Crime Act (MLPCA) and Regulations amendments Bill 2024 is undergoing stakeholder consultations and is slated for parliamentary submission by the end of this year.
- Risk-based supervisory tools are being developed through IMF technical assistance.
- Measures under way:
  - Ensure supervision of banks and non-banks and increase resource allocation for DNFBP supervision.
  - Increase FIU capacity through adoption of an IT system with support from AUSTRAC.
  - Consider the region’s CBR Roadmap and related World Bank regional project in relation to CBR concerns.

### Authorities’ views on financial stability
- Authorities agree with staff’s assessment and recommendations aimed at safeguarding financial stability and will closely monitor and address financial sector risks.
- Strategies initiated to address elevated NPLs include enhanced monitoring, collateral reassessment mandates, directives to mitigate exposure risks, and sensitivity analyses to evaluate repercussions of high NPLs on capital adequacy.
- NRBT is advancing reforms: updating prudential standards on credit risk, adopting IFRS 9 with assistance from PFTAC, and extending regulatory cover to pension funds and insurance companies with technical assistance from the World Bank and ADB.
- Authorities are concerned about a potential loss of CBR, especially for USD-denominated accounts, and appreciate the region CBR’s Roadman project led by the World Bank.

### Structural reform priorities
- Enhance resilience to natural disasters and climate change; the DRM bill passed in August 2021 shifts focus to ex-ante risk mitigation and preparedness.
- Expand classification of climate change-related spending and strengthen social protection.
- Address macro-critical corruption and governance vulnerabilities across fiscal governance, regulatory frameworks, central bank governance, and AML/CFT measures.
- Develop the private sector: digitalization (national digital ID system), better allocation of increased government spending on education and training, reduce gender inequality in the labor market and access to credit, tackle regulatory restrictions to attract FDI, and implement talent retention policies.
- Authorities’ stated targets and priorities include providing affordable, quality transport infrastructure, enhancing public utilities and social protection aiming at reducing multi-dimensional poverty (at about 24 0 percent), fostering youth training and capacity building, and an ambitious renewable power generation goal (70 percent by 2027).

### Data gaps and capacity development
- Significant remaining data gaps hinder surveillance; issues with consistency, frequency, and timeliness persist across real, fiscal, external, and monetary sectors.
- Priority data improvements: labor market data, a measure of core inflation, more frequent GDP releases including expenditure components, and reconciliation between grants in the BoP and government finance statistics.
- Ongoing and planned Fund CD initiatives:
  - Resumption of national accounts compilation with desk-based support from PFTAC; national accounts publication has resumed and is expected to return to its former schedule by FY 2025.
  - Future assistance to focus on timely publication of a FY 2023 estimate, implementation of efficiency measures developed in FY 2024, and FY 2025 activities including real sector and external sector statistics, macroeconomic programming and analysis, macroeconomic frameworks, public financial management, and revenue administration.
- Authorities are increasing Statistical Department staffing and strengthening collaboration with other ministries; progress noted in BoP timeliness and ongoing efforts to reduce the lag in IIP statistics with IMF TA.

### Staff appraisal — succinct synthesis (selected points)
- Economic recovery has continued; GDP is projected to accelerate further supported by robust domestic demand, large public investment projects, and a rebound in agricultural output as El Nino effects subside.
- Medium-term growth prospects remain weak due to frequent natural disasters and risk of faster emigration; rising banking sector vulnerabilities pose a downside tail risk.
- The external position in FY2024 was broadly in line with fundamentals and desirable policy settings; current account deficit is estimated to have widened in FY2024 due to higher import needs for reconstruction-related capital goods, but FX reserves remained adequate.
- Near-term fiscal stance: expansionary in FY2024 and expected to moderate to mildly expansionary in FY2025; overall fiscal balance is estimated to have remained in surplus in FY2024 at 3.5 percent of GDP, driven mostly by record-high grant inflows.
- Over the medium term, gradual and credible fiscal consolidation and additional grant financing commitments are warranted; Tonga is assessed as being at high risk of debt distress without additional grant commitments.
- Monetary policy: current stance is appropriately accommodative as consumer price inflation is expected to stabilize below the 5 percent reference rate; tightening would be warranted if demand-driven domestic inflation pressures resurface coupled with signs of accelerating bank lending.
- Financial sector: maintain strong capitalization and ample liquidity, but take proactive measures to tackle asset quality risks and broaden NRBT’s remit to cover NBFIs such as pension funds.
- Structural reforms: enforce Building Codes, facilitate relocation to safer grounds, reduce gender inequality, increase public investment in training and education, accelerate digital adoption, cut red tape, strengthen AML/CFT, and address macro-critical corruption and governance vulnerabilities.
- Data: allocate ample resources to ensure production of timely and more reliable macroeconomic statistics for policymaking and surveillance.

*Source: 1tonea2024001-print-pdf*

### 45. It is recommended that the next Article IV consultation for Tonga take place on a

### 1tonea2024001-print-pdf - 45. It is recommended that the next Article IV consultation for Tonga take place on a

### Key procedural recommendation
- It is recommended that the next Article IV consultation for Tonga take place on a standard 12-month cycle.

### Real sector developments
- Construction and tourism-related services are leading the recovery.
- Labor market has tightened significantly.
- Electricity consumption has been strong, while agricultural production was affected by El Nino.
- Tourists are returning after border reopening in August 2022.
- Headline inflation has declined below the NRBT’s reference rate.
- Decline in import prices has helped reduce inflation.

- Selected growth and price indicators (as reported):
  - Real GDP: -1.3 0.0 2.0 1.8 2.4
  - Consumer prices (period average): 3 1.4 8.5 10.2 4.6 3.2
  - Consumer prices (end of period): 3 6.9 11.3 7.4 5.4 3.0

### External sector developments
- Donors’ aids are expected to moderate after FY24.
- Trade deficits remain structurally large driven by imports.
- Increase in travel receipts is expected to be partially offset by moderation in official receipts, contributing to a slow narrowing of current account deficits.
- The REER has appreciated recently due to both nominal appreciation and high inflation.
- Reserves are expected to remain more than adequate.

- Balance of payments and external figures (selected):
  - Current account balance (in percent of GDP): -31.2 -32.4 -34.6 -40.6 -44.1
  - Trade balance (in percent of GDP): -199.1 -201.0 -222.3 -244.7 -255.9
  - Exports, f.o.b.: 16.2 15.1 13.1 12.9 15.4
  - Imports, f.o.b.: 215.4 216.1 235.4 257.6 271.4
  - Tourism receipts: 9.1 9.9 43.9 49.9 55.0
  - Total remittances: 220.8 215.9 256.0 263.1 274.2
  - Gross official foreign reserves (millions of U.S. dollars): 320.7 378.5 388.8 386.1 403.9
  - Reserves (months of next year's total imports): 11.7 11.8 11.2 10.6 10.7
  - Current account balance (in percent of GDP, alternative listing): -6.8 -6.8 -6.6 -7.4 -7.7

### Monetary sector developments
- Monetary policy was tightened in February 2023.
- Stock of broad money is expected to remain largely unchanged, with expected increase in net domestic assets offsetting the decrease in net foreign assets.
- Liquidity in the banking system remains high.
- Credit to the private sector is picking up; loan-to-deposit ratio remains low due to increase in total deposits.
- Zero interest rate on banks’ exchange settlement account (excess reserves) at NRBT reported.

- Monetary aggregates and credit (selected):
  - Broad money (M2) annual percent change: 25.0 13.4 -0.3 1.7 3.6
  - Domestic credit (annual percent change): -8.2 -3.3 -15.6 38.5 6.2
  - Private sector credit (annual percent change): 1.0 -1.0 9.0 6.8 5.0
  - Loan-to-deposit ratio (in percent): 50 60 70 80 90 100 110 (trend shown; specific value FY2024 (Q3) reported)
  - Central government demand deposits in commercial banks (trend shown, in millions of Pa'anga) and Excess Reserve Ratio (RHS in percent of total deposits).

### Fiscal sector developments
- The primary fiscal balance is expected to deteriorate in FY24 and turn into deficit in FY25.
- Tax revenues expected to remain stable after a small uptick thanks to tax on international trade.
- Development partners stepped up grant support after the natural disaster, but temporarily.
- Current expenditure expected to stay elevated in the short term to support reconstruction.
- Existing capital grants are expected to cover increased post-HT-HH capital expenditure needs.
- Public debt remains low, external debt remains below the fiscal anchor.

- Fiscal aggregates (selected, percent of GDP):
  - Revenue: 49.6 47.3 53.5 52.5 41.5
  - Grants (of which): 23.0 19.9 27.6 26.7 15.8
  - Expenditure: 50.6 48.1 47.4 49.0 49.5
  - Expense: 42.9 42.0 39.6 37.2 38.6
  - Net acquisition of nonfinancial assets: 7.7 6.1 7.8 11.8 10.9
  - Primary balance: -0.6 -0.2 6.7 3.9 -7.5
  - Overall balance: -1.0 -0.7 6.0 3.5 -8.0
  - Overall balance (excl. grants): -24.0 -20.7 -21.5 -23.3 -23.7
  - Fiscal anchor on domestic revenue = 22% of GDP (noted)

- From Table 4 (projections and fiscal anchors):
  - Total Revenue (percent of GDP): 47.3 53.5 52.5 41.5 38.9 37.1 35.5 33.6
  - Grants (percent of GDP): 19.9 27.6 26.7 15.8 13.0 11.3 9.7 7.7
  - Total Expenditure (percent of GDP): 48.1 47.4 49.0 49.5 48.5 47.2 46.2 45.8
  - Overall balance (percent of GDP): -0.7 6.0 3.5 -8.0 -9.6 -10.0 -10.7 -12.2
  - Primary balance (percent of GDP): -0.2 6.7 3.9 -7.5 -9.1 -9.4 -9.9 -11.3
  - Fiscal anchors flagged: Compensation of employees (in percent of domestic revenue) < 53; Domestic revenue (in percent of GDP) > 22; External debt (in percent of GDP) < 50

### Financial sector developments
- Capital buffers are similar to the PIC average.
- Bank income continues to rely on net interest income (49%).
- Interest rate spreads remain wide; banks remain profitable.
- Non-performing loans (NPLs) have increased recently, followed by a decline in provision coverage.
- Capital adequacy and profitability:
  - Capital Adequacy Ratio (in percent) trend shown; PIC average comparison presented.
  - Return on Assets (in percent) Tonga vs. PIC Average: Tonga Return on Assets and PIC Average Return on Assets trend shown.
  - Non-performing Loans to Total Gross Loans (in percent) and NPL provision coverage (in percent of total NPL) trends shown.
  - Financial sector operating income components in 2023: Net Interest Income 49%; Net Income from Foreign exchange 28%; Commission and Charges 5%; Other 18%.

- Financial soundness indicators (selected):
  - Non-performing Loans to Total Gross Loans (percent): 6.7 4.1 3.6 3.2 4.1 3.3 6.3 10.4 (FY2016–FY2023)
  - Regulatory Capital to Risk-Weighted Assets: 34.0 29.4 28.3 30.5 31.6 31.4 33.6 32.8
  - Return on Assets (percent): 3.6 2.7 3.2 2.9 1.7 2.4 2.2 4.0
  - Liquid Assets to Total Assets (percent): 33.5 32.4 27.1 25.6 27.9 40.2 44.6 37.6

### Selected statistical tables and medium-term outlook highlights
- Table 1 (Selected Economic Indicators, FY2021–FY2025) and Table 2 (Balance of Payments Summary, FY2021–FY2029) provide detailed FY2021–FY2029 projections for output, prices, fiscal accounts, money and credit, balance of payments, reserves, and debt.
- Medium-term baseline (Table 5) key projections:
  - Real GDP: 0.0 2.0 1.8 2.4 2.0 1.6 1.4 1.2 (FY2022–FY2029 sequence as presented)
  - Consumer prices (end of period): 11.3 7.4 5.4 3.0 2.9 2.8 3.0 3.0
  - Gross international reserves (end of period, millions of U.S. dollars): 378.5 388.8 386.1 403.9 419.1 434.2 449.9 474.7
  - Public sector external debt (percent of GDP): 41.3 37.8 32.3 38.0 45.1 52.1 59.4 67.9
  - Public sector total debt (percent of GDP): 47.5 43.3 37.8 44.0 51.9 60.0 68.6 78.6

*Source: Tonga: staff report figures, tables, and projections as presented in the supplied content.*

### 8. Decent Work & Economic Growth10. Reduce Inequalities

### 8. Decent Work & Economic Growth10. Reduce Inequalities

### Annex I. External Sector Assessment — Overall assessment and policy responses
- Overall Assessment: Tonga's external position in FY2024 was broadly in line with the level implied by fundamentals and desirable policy settings, based on the results of the IMF's EBA-lite current account model.
- Potential Policy Responses:
  - Strengthen public finances and promote private sector development.
  - Continue strong financial support from development partners to preserve external sector stability amid large development spending needs.

### Foreign assets and liabilities: position and trajectory
- Background:
  - Tonga's debt obligations are largely external.
  - Over half of its external public debt is to China, with a sharp spike in debt repayments due from FY2024 onwards.
  - Total public and publicly guaranteed (PPG) external debt stood at about 38 percent of GDP as of end FY 2023, accounting for 87 percent of total public debt.
  - Outstanding debt to all multilateral creditors stood at about 18 percent of GDP, or about 46 percent of the total external debt stock.
- Assessment:
  - External debt-to-GDP ratio expected to decline from 37.8 percent in FY2023 to 32.3 percent in FY2024, reflecting large repayments to China Exim Bank.
  - From FY2025 onwards, Tonga will need to incur new external debt to help finance large spending needs to achieve SDGs and climate resilience.

### Current account (CA) developments and assessment
- Background:
  - From FY2014 to FY2023, Tonga’s current account (CA) deficit averaged about 7.8 percent of GDP.
  - For FY2024:
    - Private remittance remained strong.
    - Tourist arrivals continued to recover following border reopening in August 2022.
    - Imports increased due to economic recovery and strong construction activity.
    - Overall CA deficit is estimated to have widened from 6.6 percent of GDP in FY2023 to 7.4 percent of GDP in FY2024.
  - Projection: CA deficit projected to continue to increase in FY2025, reflecting strong imports and the decline in grants and private remittance partially offset by tourism recovery.
- EBA-lite model results (FY2024, in percent of GDP):
  - CA-Actual: -7.4
  - Cyclical contributions (from model): (-)-0.1
  - Natural disasters and conflicts: (-)0.7
  - Adjusted CA: -8.0
  - CA Norm (from model): -8.0
  - Adjusted CA Norm: -8.0
  - CA Gap: 0.0
  - o/w Relative policy gap: 4.2
  - Elasticity: -0.3
  - REER Gap (in percent): -0.1
- Assessment:
  - With a gap close to 0 percent of GDP, the external position in FY2024 is assessed to be broadly in line with medium-term fundamentals and desirable policies.
  - The policy gap (4.2 percent of GDP) primarily reflects relatively looser fiscal policy in the rest of the world.

### Real effective exchange rate (REER)
- Background:
  - Tonga pa’anga exchange rate determined by a weighted-basket of currencies: US dollar, New Zealand dollar, Fijian dollar, Australian dollar, British pound, Japanese yen, and the euro.
  - Basket weights determined based on trade shares; weights unchanged since 2018 and last reviewed in September 2023.
  - REER appreciated by about 2.8 percent on average in July 2023–April 2024, reflecting NEER appreciation by about 2.2 percent and Tonga’s higher inflation relative to major trading partners.
- Assessment:
  - CA gap model implied REER gap is close to -0.1 percent (using estimated trade-balance elasticity of -0.25).
  - Large uncertainty around assessment because:
    - Official BOP data for FY2024 are yet to be published.
    - Expected changes in grants, tourism receipts, and remittances are unusually large.
    - Recent inflation developments affect both the CA and the REER.

### Capital and financial accounts: flows and policy measures
- Background:
  - Recent CA deficits largely financed by capital account credits in the form of project support grants and grants in-kind.
  - FDI inflows limited due to structural impediments: cumbersome land leasehold market operations and regulatory barriers, including longstanding restrictions prohibiting non-residents’ ownership in certain sectors.
  - Recent external borrowings limited and exclusively on concessional terms, including IMF’s RCF disbursed in FY2021 and FY2023.
- Assessment:
  - Authorities’ efforts to pursue additional grants and avoid new non-concessional external borrowing are appropriate.
  - Ongoing reform to promote FDI by reducing market entry barriers would help strengthen reserve buffer.

### FX intervention and reserves level
- Background:
  - Gross official reserves were US$386 million (about 10.6 months of the following year’s imports) in FY2024, compared to US$389 million (11.2 months of imports) in FY2023.
  - Reserves remained comfortable due to inflows of foreign grants for rebuilding, continued remittances inflows, and tourism recovery.
  - Medium-term pressures: moderation in remittances to pre-pandemic levels, lower grants after current commitments, and rising debt repayments; external government borrowings expected to support reserves.
  - Reserve coverage projected to remain stable in FY2024 and over the medium term.
- Reserve adequacy analysis (FY2024):
  - Actual Reserves (months of prospective imports): 10.6
  - Optimal level with standard shock probability: 4.6
  - Optimal level with higher shock probability: 7.3
  - Optimal level taking into account debt repayment: 8.0
  - Broad Money coverage: 113%
- Assessment and policy implications:
  - Cost-benefit analysis suggests optimal reserves between 4½ and 7½ months of imports.
  - If probability of a large shock set at sample average of 50 percent, estimated optimal reserves = 4½ months of imports (above NRBT’s minimum threshold of 3 months).
  - Incorporating Tonga’s high vulnerability to natural disasters raises estimated adequate reserves to about 7½ months of imports.
  - Additional reserve buffers may be needed to cover pickup in debt repayments from FY2024 onwards, mostly due to China Exim Bank.
  - Recommended measures: strengthen public finances, implement structural reforms to enhance climate resilience and promote private sector development, and secure new grant commitments from donors.

### Annex II. Risk Assessment Matrix — key risks, likelihood, expected impact, and policy recommendations
- Global: Commodity price volatility
  - Likelihood: High
  - Expected impact: Medium-High (larger import bill and CA deficit; lower FX reserves; higher inflation; weaker private consumption; reconstruction/investment delays)
  - Policy recommendation: Provide targeted fiscal support to the vulnerable; tighten monetary policy if strong second-round effects materialize; prioritize and increase public investment to expand productive capacity.
- Global: Global growth surprises
  - Likelihood: Medium
  - Expected impact: Medium (growth slowdown → weaker remittances, grants, tourism; acceleration → improved external conditions)
  - Policy recommendation: Provide targeted fiscal support; improve private sector business climate and diversify economy; accelerate reforms to broaden tax base and improve spending efficiency.
- Domestic: Extreme climate events
  - Likelihood: High
  - Expected impact: High (disruptions to activity; lower GDP growth; inflationary pressures; damage to infrastructure; larger fiscal burden and public debts)
  - Policy recommendation: Prioritize ex-ante adaptation investment and ex-post support; strengthen monitoring of banking asset quality; strengthen fiscal buffers by accelerating revenue mobilization reforms.
- Domestic: Acceleration of outward migration
  - Likelihood: High
  - Expected impact: Medium (tighter labor market, higher inflation pressures; lower long-term growth)
  - Policy recommendation: Create economic opportunities via private sector development, attract FDI, diversify economy; enhance education and skill development.
- Domestic: Higher or more persistent inflation
  - Likelihood: Medium
  - Expected impact: Medium-High (loss in real purchasing power; lower consumption; wage-price spiral; social unrest)
  - Policy recommendation: NRBT should be ready to tighten monetary policy; provide targeted fiscal support to low-income households.
- Domestic: Partial withdrawal of correspondent banking relationships (CBRs), including due to AML/CFT gaps
  - Likelihood: Medium
  - Expected impact: High (lower remittances, weaker private consumption, larger CA deficit)
  - Policy recommendation: Strengthen AML/CFT framework and implementation; implement risk-based supervision and improve enforcement; pass the MLPCA and Regulation amendments Bill; consider regional CBR Roadmap and related World Bank regional project.
- Domestic: Further increase in non-performing loans (NPLs)
  - Likelihood: Medium
  - Expected impact: Medium-High (lower lending activity, tighter lending conditions, lower GDP growth)
  - Policy recommendation: NRBT should closely monitor asset quality and strengthen bank oversight; consider requesting banks to prepare comprehensive NPL reduction plans with minimum provisioning targets.

### Annex III. Integration matrix of surveillance issues and capacity building (selected)
- Fiscal sector: Public Financial Management, Expenditure framework, Revenue Framework — past and planned/ongoing engagement.
- Real sector: Macroeconomic Frameworks — past and planned.
- Macro-financial issues: Financial supervision and regulation; Financial market development; Correspondent Banking — past and planned/ongoing engagement.
- Macro-structural issues: Infrastructure; Private sector development; Governance issues; Poverty/Gender/Inequality; Climate change; Natural disaster management; Financial Inclusion; Gender; Labor markets; Land; Business climate; AML/CFT.
- Statistics: Data Enhancement — past and planned engagement.
- Sources for the matrix: IMF, World Bank, and Asian Development Bank (ADB).

### Annex IV. Recommendations from 2023 Article IV Consultation — main recommendations and actions since 2023
- Fiscal policies:
  - Recommendation: Combination of domestic fiscal measures and additional donor support needed to meet large development spending needs while reducing risk of debt distress.
  - Action: Authorities pursued additional grants from development partners (World Bank, ADB, government of Australia), reaching record-high levels in FY24.
  - Recommendation: Continue reforms to broaden the tax base and improve spending efficiency.
  - Action: Electronic Sales Register System regulations gazetted in June 2022; by March 2023, 54 businesses across 163 outlets registered onto the system.
  - Recommendation: Manage scheduled pickup in debt repayment in FY2024.
  - Action: Government set up a Debt Repayment Sinking Fund to facilitate timely repayments, including to China EXIM Bank.
- Monetary policy:
  - Recommendation: Tighten monetary policy stance if inflation expected to stay above the reference rate for longer.
  - Action: NRBT increased statutory reserve deposit (SRD) ratio from 10 to 15 percent in February 2023.
- Financial sector policies:
  - Recommendation: Improve financial supervision and develop macroprudential policy framework.
  - Action: With PFTAC assistance, NBRT working on regulatory/supervisory frameworks for non-banking credit institutions and foreign exchange dealers.
  - Recommendation: Support credit and promote financial deepening and inclusion.
  - Action: Authorities support lending to MSMEs and low-income households, including subsidized interest loans under Government Development Loan scheme; additional schemes studied in NRBT Act amendments.
- Structural policies:
  - Recommendation: Enhance resilience to natural disasters and climate change.
  - Action: Reconstruction projects implemented under comprehensive plan, with 8 out of 20 high-priority projects completed.
  - Recommendation: Develop private sector to boost long-term growth potential.
  - Action: Authorities working on promoting digitalization, including efforts to launch a national digital ID system.
  - Recommendation: Continue to reinforce AML/CFT framework.
  - Action: Tonga advanced on updating AML/CFT legislation with LEG technical assistance; draft amendments and implementing regulations expected to be submitted to Parliament by the end of the year.

*Source: Tonga's Voluntary National Review 2019; IMF staff report annexes and assessments as presented in the source content.*

### Annex V. Data Issues

### Annex V. Data Issues

### Assessment Summary
- Data Adequacy Assessment Rating: C
- Median Rating by sector: C B C C C D C

### Detailed Questionnaire Results (Data Quality Characteristics)
- Coverage:
  - National Accounts: C
  - Prices: B
  - Government Finance Statistics: C
  - External Sector Statistics: B
  - Monetary and Financial Statistics: C
- Granularity (top cell = government operations; bottom cell = public debt / MFS and FSI):
  - Government Finance Statistics (operations): C
  - Government Finance Statistics (public debt): C
  - Monetary and Financial Statistics (MFS): C
  - Monetary and Financial Statistics (Financial Soundness indicators): C
- Consistency:
  - National Accounts: C
  - Prices: C
  - Government Finance Statistics: C
  - External Sector Statistics: D
- Frequency and Timeliness:
  - National Accounts: C
  - Prices: B
  - Government Finance Statistics: C
  - External Sector Statistics: C
  - Monetary and Financial Statistics: C

Note: When the questionnaire does not include a question on a specific dimension of data quality for a sector, the corresponding cell is blank.

### Rationale for Staff Assessment and Changes Since Last Consultation
- Overall assessment: "Overall data provided to the Fund has some shortcomings that somewhat hamper surveillance, partially reflecting the capacity issues for a small island country."
- Specific issues and gaps:
  - Labor market data: Insufficient — labor market data would help monetary policy advice complementing inflation data, especially with a published measure of core inflation.
  - External Sector: Significant delays in releasing data on the External Sector, particularly IIP.
  - GDP: More frequent GDP releases, including expenditure components, would help assess current economic conditions.
  - BOP and IIP: Timely publication of the Balance of Payments and International Investment Position is needed.
  - Grants: Significant inconsistency in grants exists between the BoP and GFS; reconciliation between BoP and government finance statistics is relevant.
  - Monetary and Financial Statistics: Good bank level data available; improvements needed for NBFI data.
- Changes since last Article IV consultation: "Tonga Statistical Department has made progress in enhancing the timeliness of the statistics in GDP and BoP."

### Corrective Actions and Capacity Development Priorities
- Authorities should continue efforts to enhance statistical capacity by:
  - Enhancing training and ensuring adequate staffing.
  - CD priorities include strengthening statistics on:
    - GDP
    - Government Finance Statistics (GFS)
    - External sector including BOP and IIP
    - Monetary and financial sectors

### Use of Data in Article IV Consultation
- "Staff do not use data and/or estimates different from official statistics."

### Other Data Gaps
- Labor Market & Gender data:
  - unemployment
  - employment
  - labor force participation data by gender, by age
- Housing market data
- SOE balance sheet data
- Excess Reserves at the NRBT

### Table 2. Data Standards Initiatives
- Tonga participates in the Enhanced General Data Dissemination System (e-GDDS).
- Tonga first posted its metadata in May 2006 but is yet to disseminate the data recommended under the e-GDDS.

### Table 3. Table of Common Indicators Required for Surveillance (As of September 12, 2024)
Data Provision to the Fund / Publication under the Data Standards Initiatives through the National Summary Data Page
- Exchange Rates:
  - Date of Latest Observation: 6/2024
  - Date Received: 8/2024
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Expected Frequency: D
  - Tonga Expected Timeliness: Q ... D
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities:
  - Date of Latest Observation: 6/2024
  - Date Received: 7/2024
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Expected Frequency: M
  - Tonga Expected Timeliness: 1M 2W
- Reserve/Base Money:
  - Date of Latest Observation: 6/2024
  - Date Received: 9/2024
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Expected Frequency: M Q
  - Tonga Expected Timeliness: 2M 6W
- Broad Money:
  - Date of Latest Observation: 6/2024
  - Date Received: 8/2024
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Expected Frequency: M Q
  - Tonga Expected Timeliness: 1Q 6W
- Central Bank Balance Sheet:
  - Date of Latest Observation: 6/2024
  - Date Received: 9/2024
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Expected Frequency: M Q
  - Tonga Expected Timeliness: 2M 6W
- Consolidated Balance Sheet of the Banking System:
  - Date of Latest Observation: 6/2024
  - Date Received: 9/2024
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Expected Frequency: M Q
  - Tonga Expected Timeliness: 1Q 6W
- Interest Rates:
  - Date of Latest Observation: 7/2024
  - Date Received: 9/2024
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Expected Frequency: M M
  - Tonga Expected Timeliness: ... 6W
- Consumer Price Index:
  - Date of Latest Observation: 7/2024
  - Date Received: 9/2024
  - Frequency of Data: M
  - Frequency of Reporting: M
  - Expected Frequency: M M
  - Tonga Expected Timeliness: 2M 2W
- Revenue, Expenditure, Balance and Composition of Financing ‒ General Government:
  - Date of Latest Observation: 2022/23
  - Date Received: 5/2024
  - Frequency of Data: A
  - Frequency of Reporting: A
  - Expected Frequency: A
  - Tonga Expected Timeliness: ... 3Q ...
- Revenue, Expenditure, Balance and Composition of Financing ‒ Central Government:
  - Date of Latest Observation: 2022/23
  - Date Received: 5/2024
  - Frequency of Data: A
  - Frequency of Reporting: A Q
  - Expected Frequency: Q SA
  - Tonga Expected Timeliness: 1Q 9-10M
- Stocks of Central Government and Central Government-Guaranteed Debt:
  - Date of Latest Observation: 03/2024
  - Date Received: 4/2024
  - Frequency of Data: Q
  - Frequency of Reporting: Q
  - Expected Frequency: Q A
  - Tonga Expected Timeliness: 2Q 1Y
- External Current Account Balance:
  - Date of Latest Observation: Q4/2023
  - Date Received: 8/2024
  - Frequency of Data: Q
  - Frequency of Reporting: Q
  - Expected Frequency: Q A/Q
  - Tonga Expected Timeliness: 1Q 8W/4M
- Exports and Imports of Goods and Services:
  - Date of Latest Observation: Q4/2023
  - Date Received: 8/2024
  - Frequency of Data: Q
  - Frequency of Reporting: Q
  - Expected Frequency: M Q
  - Tonga Expected Timeliness: 12W 4W
- GDP/GNP:
  - Date of Latest Observation: 2022/23
  - Date Received: 4/2024
  - Frequency of Data: A
  - Frequency of Reporting: A
  - Expected Frequency: Q A
  - Tonga Expected Timeliness: 1Q 4M
- Gross External Debt:
  - Date of Latest Observation: 2022/23
  - Date Received: 5/2024
  - Frequency of Data: A
  - Frequency of Reporting: A
  - Expected Frequency: Q A
  - Tonga Expected Timeliness: 2Q 9-12M
- International Investment Position:
  - Date of Latest Observation: 2021
  - Date Received: 4/2023
  - Frequency of Data: A
  - Frequency of Reporting: A
  - Expected Frequency: A ...
  - Tonga Expected Timeliness: 3Q ...

Notes from Table 3 (as presented):
- 1 Includes reserve assets pledged or otherwise encumbered, as well as net derivative positions.
- 2 Both market-based and officially determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.
- 3 Foreign, domestic bank, and domestic nonbank financing.
- 4 The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.
- 5 Including currency and maturity composition.
- 6 Frequency and timeliness codes defined: (“D”) daily; (“W”) weekly or with a lag of no more than one week after the reference date; (“M”) monthly or with lag of no more than one month after the reference date; (“Q”) quarterly or with lag of no more than one quarter after the reference date; (“A”) annual.; ("SA") semiannual; ("I") irregular; ("NA") not available or not applicable; and ("NLT") not later than.
- 7 Encouraged frequency of data and timeliness of reporting under the e-GDDS and required frequency of data and timeliness of reporting under the SDDS and SDDS Plus. Any flexibility options or transition plans used under the SDDS or SDDS Plus are not reflected.
- 8 Based on information from the Summary of Observance for SDDS and SDDS Plus participants, and the Summary of Dissemination Practices for e-GDDS participants.

*Source: Annex V. Data Issues, 1tonea2024001-print-pdf - Annex V. Data Issues.*

### Conclusion

### Conclusion

### Monetary policy instruments and operational constraints
- Adjusting the mandatory reserve ratio offers a basic mechanism for influencing inflation and economic activity, but its effectiveness is hampered by sticky lending rates and the presence of sizeable excess reserves.
- A more sound monetary policy instrument is a policy rate (at which reserves at the central bank are exchanged), which typically requires development of an interbank market.
- Issuing domestic government debt that can be used as collateral in the interbank market (and is readily exchangeable with the central bank) would increase interbank liquidity.
- Even in the absence of a liquid interbank market, adjusting the interest rate floor on excess reserves would be a potent signaling device.
- By influencing the relative attractiveness of lending versus idle reserves, an interest rate on reserves can more directly impact lending rates.
- Paying interest on reserves can entail potential monetary costs to the NRBT, raising questions regarding its financial sustainability and operational autonomy that should be clarified in the NRBT Act.

### Annex VII — Fiscal Rules in Tonga: structure and performance
- Since 2017, Tonga has implemented a fiscal rule in its Budget Statement with four fiscal anchors:
  - Compensation of employees in percent of domestic revenue <53
  - Compensation of employees in percent of current expense <45
  - Domestic revenue in percent of GDP >22
  - External debt in percent of GDP <50
- The compensation for public employees as a percentage of domestic revenue was initially set at 50 percent and was eased to 53 percent following Tropical Cyclone Gita in 2018.
- Historical adherence and breaches:
  - The public wage bill to current expense ratio and external debt as a percentage of GDP have remained below their respective thresholds since introduction.
  - Domestic revenue has consistently surpassed the 22 percent of GDP target.
  - The fiscal rule was breached in FY 2021 and FY 2022, with the public wage bill exceeding 53 percent of domestic revenue.
    - The FY 2021 breach stemmed primarily from a 6.8 percent increase in nominal compensation coupled with a 1.5 percent decrease in nominal domestic revenue.
  - A projected 0.7 percent increase in nominal compensation and a 5.7 percent increase in domestic revenue in FY 2024 are expected to partially rectify prior breaches.
  - A budgeted 15 percent increase in compensation of employees for FY 2025 would lead to a breach in FY 2025 and beyond.

### Fiscal rules — outcomes and contribution to debt sustainability
- Since implementation, domestic revenues have consistently exceeded the 22 percent threshold, and the fiscal rule has contributed to containing fiscal deficits and a steady decline of external debt as a percentage of GDP.
- The compensation of employees as a percentage of domestic revenue is identified as the most effective anchor over the past seven years; the decline in external debt to GDP paused when this rule was breached.
- The government has sought further improvements to the fiscal rule framework with assistance from development partners.

### Recommendations to strengthen the fiscal rule framework
- Clearly articulate the rationale for the 53 percent threshold for employee compensation as a percentage of domestic revenue.
- Strengthen enforcement by specifying actions triggered by breaches of fiscal anchors (for example, automatic spending adjustments or revisions to future budgets).
- Explore legal or policy safeguards to guarantee rule implementation.
- Improve institutional processes:
  - Strengthen revenue collection mechanisms.
  - Enhance procurement processes with transparency and efficiency.
  - Promote timely and accurate fiscal reporting and accountability mechanisms.
  - Consider establishing a fiscal council for independent oversight and analysis.
- Introduce an escape clause that is automatically triggered with clearly defined expiration criteria.
- Leverage the Medium-Term Fiscal Framework (MTFF) for setting wage limits based on projections of other variables and objectives related to deficit and debt reduction.
- Consider Public Financial Management (PFM) reforms to control the wage bill, including stricter hiring guidelines or performance-based compensation structures.

### Suggested reforms to address structural drawbacks and resilience
- Amend the framework to incentivize savings from windfall revenues and promote revenue-increasing measures to avoid structural spending increases.
- Address the procyclical bias by adjusting for the business cycle and fluctuations in grants.
- Broaden the focus from wages to total current expenditure to prevent circumvention of the wage bill limit through alternative compensation schemes.
- Given Tonga’s vulnerability to natural disasters, consider incorporating provisions for building fiscal buffers to manage climate-related and disaster-related shocks in the medium to long term.

*Source: 1tonea2024001-print-pdf - Conclusion*

### 3.      Tonga's debt obligations are largely external, and over half of its external public debt is to

### 1tonea2024001-print-pdf - 3.      Tonga's debt obligations are largely external, and over half of its external public debt is to

### Debt stock and creditor composition
- Total public and publicly guaranteed (PPG) external debt: USD189 million (about 38 percent of GDP) as of end-June 2023, accounting for 87 percent of total public debt.
- Outstanding debt to all multilateral creditors: USD88 million (about 18 percent of GDP), or about 46 percent of the total external debt stock.
- Single largest creditor: Export-Import Bank of China (China Exim Bank), which accounts for 54 percent of total external debt stock.
- Loans from China Exim Bank are denominated in Chinese renminbi.

### Repayment schedule and DSSI treatment
- Tonga started repayments to China Exim Bank in FY2019 with larger repayments coming due starting in FY2024; the spike reflects both the previously extended grace period and the DSSI rescheduling.
- Under the DSSI, debt deferral amounts: 1.4 percent of GDP in FY2021 and 0.7 percent of GDP in FY2022.
- Rescheduled DSSI repayments are included in the baseline scenario (Text Table 2).
- Text Table 2: Repayment schedule for existing external debt, FY2024–34 (in percent of GDP) — selected rows:
  - Total external debt: FY2024 3.5, FY2025 3.3, FY2026 3.1, FY2027 3.0, FY2028 2.7, FY2029 1.8, FY2030 0.9, FY2031 0.3, FY2032 0.3, FY2033 0.3, FY2034 0.3
  - Multilateral: FY2024 0.5, FY2025 0.6, FY2026 0.6, FY2027 0.5, FY2028 0.5, FY2029 0.5, FY2030 0.4, FY2031 0.3, FY2032 0.3, FY2033 0.3, FY2034 0.3
  - ADB: FY2024 0.3, FY2025 0.4, FY2026 0.3, FY2027 0.3, FY2028 0.3, FY2029 0.2, FY2030 0.2, FY2031 0.1, FY2032 0.1, FY2033 0.1, FY2034 0.1
  - IDA/WB: FY2024 0.1, FY2025 0.2, FY2026 0.2, FY2027 0.2, FY2028 0.2, FY2029 0.2, FY2030 0.2, FY2031 0.2, FY2032 0.2, FY2033 0.2, FY2034 0.2
  - IMF: FY2024 0.0, FY2025 0.0, FY2026 0.0, FY2027 0.3, FY2028 0.4, FY2029 0.5, FY2030 0.4, FY2031 0.4, FY2032 0.2, FY2033 0.1, FY2034 0.0
  - Bilateral (EXIM Bank of China): FY2024 3.0, FY2025 2.8, FY2026 2.5, FY2027 2.4, FY2028 2.2, FY2029 1.3, FY2030 0.5, FY2031 0.0, FY2032 0.0, FY2033 0.0, FY2034 0.0
- Average annual payments to China Exim Bank in FY2024–29: about 2.4 percent of GDP.

### Domestic debt
- Public domestic debt: USD29 million (about 5.5 percent of GDP) at end-June 2023, accounting for 13 percent of total public debt.
- Holders: Domestic financial institutions hold about half of total domestic debt; the rest held mainly by domestic pension funds.
- Authorities plan to issue new domestic debt in FY2024 and beyond, if necessary.

### Baseline macroeconomic assumptions and medium-term projections
- Real GDP growth projected at 1.5 percent on average during FY2024–34.
  - Short-term: recovery continues in FY2024 and FY2025 driven by tourist arrivals, construction projects, and sustained demand; FY2024 growth lower than previous projection due to base effects, lower agricultural output, and reconstruction delays.
  - Long-term potential rate: 1.2 percent.
- Inflation projected to average 3.1 percent during FY2024–34; expected to converge to 3.0 percent over time.
- Non-interest current account deficit: estimated 7.1 percent of GDP in FY2024; projected average 6.8 percent of GDP over FY2024–FY2034.
- Net FDI inflows expected: 0.7 percent of GDP over FY2024–34.
- Baseline incorporates disaster assumptions:
  - FY2024–FY2025 assumed disaster-free for near-term policy discussion.
  - From FY2026 onwards, baseline lowers annual GDP growth by 0.16 percentage points to incorporate average long-term effects of natural disasters.
- Assumptions on external borrowing:
  - Except for the IMF’s second RCF-supported financing disbursed in July 2022, new external borrowing expected to commence in FY2025 and increase over the medium term to refinance repayments and the expected primary deficit.
  - Tonga has an IDA20 indicative allocation of SDR 52.2 million (about US$70.0 million), with SDR 9.8 million (US$13.0 million) committed and a remaining balance of SDR 42.3 million (about US$57.0 million).
  - World Bank IDA financing: fully grants until FY2025, then a mix until FY2028, after which fully loans.
  - Discount rate used to calculate net PV of external debt: 5 percent (default).
- International reserves: currently estimated at 10.6 months of next year’s imports at end-FY2024 and expected to remain stable in coming years despite large repayments to China Exim Bank.

### Fiscal outlook and public debt dynamics
- Primary fiscal balance expected to shift:
  - Surplus of 3.9 percent of GDP in FY2024 to a deficit of 7.5 percent of GDP in FY2025.
  - Double-digit deficits expected during FY2029–FY2033.
- Drivers:
  - FY2024 surplus driven by record-high grant inflow and stronger-than-expected consumption tax and income tax revenues.
  - FY2025 deficit reflects normalization of grants from record-high level.
  - Long-term deterioration due to lower grant inflows after existing commitments are met and sizable spending needs for infrastructure, climate resilience, and SDGs.
- Policy intentions:
  - Authorities committed to seek new concessional and grant financing to contain external debt and refrain from non-concessional borrowing consistent with World Bank SDFP.
  - Medium-term debt strategy and new public financial management (PFM) legislation to guide fiscal policy and debt management decisions.

### Debt-carrying capacity, stress tests, and DSA outcomes
- Composite Indicator (CI) index: 3.06 (based on April 2024 WEO and 2022 CPIA); CI rating: Strong (CI must be greater than 3.05 to be assessed as strong).
- Natural disaster tailored one-time stress test:
  - EM-DAT largest damage during 1980–2016: 28.2 percent of GDP.
  - DSA assumes a one-off shock of 14 percentage points to the debt-to-GDP ratio in FY2025.
  - Real GDP growth lowered by 3 ppts and exports lowered by 7 ppts in year of shock.
  - World Bank Catastrophe Deferred Drawdown Option can help mitigate impacts.
- External debt sustainability under baseline:
  - PV of external debt-to-GDP ratio expected to decline from 37.8 percent in FY2023 to 32.3 percent in FY2024 reflecting large repayments to China Exim Bank.
  - From FY2025 onwards, new external borrowing will be needed; external debt-to-GDP ratio will breach the authorities’ fiscal anchor of 50 percent in FY2027.
  - PV of external debt-to-GDP ratio expected to breach the threshold of 55 percent starting from FY2034.
  - Under an export shock, the PV of external debt-to-GDP ratio would breach the threshold earlier in FY2032.
- Judgment applied to reflect long-run climate-related risks; threshold breaches beyond the ten-year horizon reflect Tonga’s vulnerability to natural disasters and climate change.

*Source: 1tonea2024001-print-pdf (IMF)*

### 11.      The tailored natural disaster shock would significantly worsen the external debt path (Table

### 1tonea2024001-print-pdf - 11.      The tailored natural disaster shock would significantly worsen the external debt path (Table

### Natural disaster shock and external external-debt dynamics
- The tailored natural disaster (one-off) shock would cause the PV of external debt-to-GDP ratio to jump in FY2025 when the one-off shock is assumed, and cause the PV of external debt-to-GDP ratio to breach the threshold two years earlier in FY2032.
- Multiple severe natural disasters within a ten-year timeframe could have a larger cumulative negative effect on external debt sustainability through:
  - larger reconstruction needs that may require additional debt financing, and
  - lowering long-term growth.

### Public debt sustainability (baseline and stress scenarios)
- Baseline:
  - Under the baseline scenario, the PV of the public debt-to-GDP ratio would breach 70 percent from FY2034 onwards.
  - The public debt dynamic is driven by a large primary fiscal deficit.
  - Compared to the previous DSA, nominal public debt-to-GDP ratio is lower from FY2024 onward due to higher-than-expected grants committed in FY2024.
- Standardized sensitivity and extreme shocks:
  - The most extreme shock scenario is the growth shock, where growth rate is one standard deviation below the baseline for two years starting from 2025.
  - Under the multi-year GDP growth shock, the PV of the public debt-to-GDP ratio would cross 70 percent of GDP in FY2032 and public debt will continue to rise until FY2044.
  - An exports shock would also cause a breach of the 70 percent threshold in FY2032.
- Tailored shocks:
  - The tailored one-time natural disaster shock worsens public debt: the PV of the public debt-to-GDP ratio would cross 70 percent of GDP in FY2032, two years earlier than in the baseline scenario.
  - A tailored stress test for the combined contingent liability shock shifts the PV of the public debt-to-GDP trajectory upwards by 4 percentage points in FY2034 from the baseline.

### Risk rating and vulnerabilities
- Tonga's risk of external debt distress is assessed as "high."
  - The LIC DSF indicates a “moderate” mechanical risk rating for external debt distress, but staff judgment upgraded to “high” because the PV of external debt-to-GDP is expected to breach its indicative threshold from FY2034 until FY2044, with breaches that are large, persistent, and likely without major policy correction.
- The overall risk of debt distress is also assessed as "high."
  - The LIC DSF indicates a “moderate” mechanical rating, but the PV of the public debt-to-GDP ratio is projected to breach its indicative benchmark from FY2034 until FY2044, reflecting large investment needs and decreasing capital grant commitments.
  - Staff assessment factors in the long-term effects of natural disasters on growth and the fiscal position.

### Short-term fiscal policy guidance
- Priorities:
  - Fiscal policy should prioritize reconstruction and protecting vulnerable groups.
  - Contain public sector wages to preserve fiscal buffers.
  - Focus on rebuilding and repairs while supporting vulnerable households.
- Containment:
  - Current spending, especially recurrent portions such as public sector wages and use of goods and services, should be contained.

### Medium-term fiscal consolidation and grant support
- A credible medium-term fiscal consolidation combined with new grant commitments could put public debt on a sustainable path:
  - Under an illustrative fiscal adjustment scenario, the PV of public debt-to-GDP could stabilize below the 70 percent threshold over the long term, even with the natural disaster or the most extreme shock (growth).
  - Fiscal adjustments could include:
    - modest improvement in consumption tax collection compliance,
    - reductions in tax exemptions,
    - reductions in current spending.
  - New grant commitments consistent with historical trends are essential to fund capital investment projects for SDGs and climate resilience.
  - The government strategy to improve revenue administration, streamline tax exemptions, collect tax arrears, contain public wage bill within the fiscal target, pursue additional grants from development partners, and avoid new non-concessional external borrowing is aligned with this fiscal path.

### Quantified fiscal figures and assumptions (selected)
- Grants and grant assumptions:
  - Cash and in-kind grants averaged 16.0 percent of GDP annually over FY2011–2019.
  - Under the baseline, staff assume continued budget support in line with historical levels and capital grants falling to zero from FY2036 onwards.
  - Additional grants in the illustrative fiscal path are to maintain grants above 10 percent of GDP.
- Baseline primary balance (selected years, in percent of GDP):
  - Baseline primary balance: -9.1, -9.4, -9.9, -11.3, -11.1, -11.6, -11.8, -11.0, -9.4 (FY2026–FY2034 sequence as shown in table).
- Proposed primary balance (selected years, in percent of GDP):
  - Proposed primary balance: -7.8, -7.5, -7.7, -7.5, -6.5, -6.2, -5.2, -2.7, 0.6 (FY2026–FY2034 sequence as shown in table).
- Domestic consolidation needed (in percent of GDP) by year (FY2026–FY2034): 1.3, 1.9, 2.2, 2.5, 2.6, 2.6, 3.1, 3.8, 4.5.
- Contributions to domestic consolidation (in percent of GDP):
  - From tax revenue (total): 0.8, 0.8, 0.8, 1.1, 1.2, 1.2, 1.7, 2.3, 2.7.
  - Improved consumption tax (IMF SR reference): 0.3, 0.3, 0.3, 0.3, 0.4, 0.4, 0.4, 0.5, 0.6.
  - Less tax exemptions (IMF SR reference): 0.5, 0.5, 0.5, 0.8, 0.8, 0.8, 1.3, 1.8, 2.1.
  - Contribution from current spending reductions: -0.5, -1.1, -1.4, -1.4, -1.4, -1.4, -1.4, -1.5, -1.8.
  - Lower public sector wage bill: -0.5, -0.8, -0.8, -0.8, -0.8, -0.8, -0.8, -0.8, -1.0.
  - Additional Grants (to keep grants above 10 percent of GDP): 0.0, 0.0, 0.0, 1.3, 2.0, 2.8, 3.5, 4.5, 5.5.
- External debt and public debt key figures (selected):
  - External debt (nominal) projections include FY2034: 107.5, FY2044: 68.9 (from table sequence).
  - PV of PPG external debt-to-GDP ratio (selected projection points shown): 22.2, 18.4, 20.4, 22.8, 25.3, 28.2, 32.2, 55.7, 79.0 (tabulated series).
  - PV of public debt-to-GDP ratio (selected projection points shown): 28.0, 24.0, 26.5, 29.7, 33.3, 37.5, 43.0, 72.3, 100.8 (tabulated series).
- Nominal GDP (Million of U.S. dollars) sequence (selected): 459, 475, 520, 545, 571, 595, 616, 638, 660, 779, 1,085 (as listed).
- Real GDP growth assumptions (in percent): -1.3, 0.0, 2.0, 1.8, 2.4, 2.0, 1.6, 1.4, 1.2, 1.2, 1.2, 1.6, 1.5 (historical/projections sequence shown).
- Grant-equivalent financing (in percent of GDP) highlighted: 23.0, 19.9, 27.6, ..., 20.7, 19.0, 17.2, 15.7, 13.8, 9.6, 8.8, ..., 14.2 (series as shown in table).

### Authorities’ views and policy measures
- Authorities agreed on the need for fiscal adjustment and stressed sustained support from development partners.
- They highlighted concerns over the high public sector wage bill, especially after the increase in FY2025, due to narrow domestic revenue base and pay differentials with New Zealand and Australia.
- Measures being taken or considered:
  - Improve consumption tax collections by rolling out the Electronic Sales Register System and upgrading the tax revenue management system.
  - Mitigate wage pressures through performance-based assessments, limiting overtime allowances, considering outsourcing some functions, and offering voluntary retirement.
  - Seek new grant financing from development partners to meet climate resilience and development goals while keeping debt on a sustainable path.

*Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1tonea2024001-print-pdf.pdf*

### 5. Depreciation20181615141065667

### 5. Depreciation20181615141065667

### Sensitivity Analysis and Key Projections (Table 4 highlights)
- Baseline PV of public debt (percent): 24.0, 26.5, 29.7, 33.3, 37.5, 43.0, 48.9, 55.3, 61.7, 67.4, 72.3 (FY2024–2034 sequence).
- Alternative scenario A1 (Key variables at historical averages in 2024-2034) PV of public debt (percent): 2/24, 21, 18, 15, 12, 10, 8, 6, 5, 3, 1 (as presented).
- Bound tests B1–B6 and tailored tests C1–C2 produce higher PV of public debt trajectories; selected extreme values reported:
  - B1. Real GDP growth PVs: 24, 29, 35, 40, 46, 52, 61, 70, 78, 85, 92.
  - B5. Depreciation PVs: 24, 29, 28, 28, 31, 34, 37, 41, 44, 47.
  - B6. Combination of B1–B5 PVs: 24, 28, 31, 33, 37, 42, 48, 55, 61, 66, 71.
  - C1. Combined contingent liabilities PVs: 24, 32, 35, 38, 42, 47, 53, 59, 66, 72, 77.
  - C2. Natural disaster PVs: 24, 37, 41, 44, 48, 54, 61, 67, 74, 81, 86.
- TOTAL public debt benchmark: 70 (repeated across projection years).
- Baseline PV of Debt-to-GDP (presented elsewhere): 46, 64, 76, 90, 106, 128, 148, 174, 197, 219, 232 (sequence shown).
- Under stress tests, ratios breach benchmarks in several scenarios (bold values indicated in original tables).

### Debt Ratios, Service, and Related Indicators (selected series)
- PV of Debt-to-GDP ratio (selected baseline sequence): 46, 64, 76, 90, 106, 128, 148, 174, 197, 219, 232.
- PV of Debt-to-Revenue ratio (baseline and scenarios shown in tables and figures): baseline 9, 12, 13, 15, 18, 18, 16, 19, 22, 23, 25 (FY2024–2034).
- Debt Service-to-Revenue ratio (baseline and scenarios shown): baseline 9, 12, 13, 15, 18, 18, 16, 19, 22, 23, 25 (mirrored presentation across panels).
- Debt service-to-exports ratio and PV of debt-to-exports ratio are presented in sensitivity matrices (numerical series available in the tables).

### Stress-Test Definitions and Assumptions
- The most extreme stress test is defined as the test that yields the highest ratio in or before 2034; one-off breaches are treated per the mechanical-signal rules described.
- Tailored test C3 (Commodity price) and C4 (Market Financing) are marked "n.a." (not applicable) in several panels.
- Grant element assumed on residual financing (i.e., financing required above baseline) is reported as 6/49 repeated across columns (series of "4949494949..." in the tables).
- Notes:
  - 1/ A bold value indicates a breach of the threshold.
  - 2/ Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.
  - 3/ Includes official and private transfers and FDI.

### Figures — Indicators under Alternative Scenarios and Drivers of Debt Dynamics
- Figures present:
  - Indicators of Public and Publicly Guaranteed External Debt under alternative scenarios (FY2024–2034) showing shares and paths for External PPG medium and long-term, Domestic medium and long-term, Domestic short-term.
  - PV of Debt-to-Revenue Ratio, Debt Service-to-Revenue Ratio, and PV of Debt-to-GDP Ratio time paths under the most extreme shock: Growth.
- Figure 3 (Drivers of Debt Dynamics—Baseline Scenario) isolates contributions (in percent of GDP) from:
  - Real GDP growth, Real interest rate, Price and exchange rate, Primary deficit, Change in PPG debt, Debt-creating flows, and Unexpected changes in debt (difference between anticipated and actual contributions).
- Historical and projected changes are compared across DSA vintages (Current DSA, Previous DSA, DSA-2017 projections).

### Realism Tools and Fiscal Adjustment
- A realism tool plots projected 3-year fiscal adjustments (primary balance) and potential real GDP growth paths under different fiscal multipliers:
  - Multipliers shown: 0.2, 0.4, 0.6, 0.8 (growth paths contrasted with baseline).
  - Distribution across Fund-supported programs for LICs is summarized with a focus on 3-Year Adjustment in Primary Balance (percentage points of GDP).
- The 3-year projected fiscal adjustment is displayed relative to historical distributions and program experience.

### Authorities’ Views, Policy Priorities, and Reforms (Statement by Tonga authorities)
- Governance and institutional context:
  - Tonga is a hereditary constitutional monarchy with a single legislative house; population just over 100,000 across around 40 of 170 islands.
  - Economy reliant on agriculture, tourism, and remittance inflows (diaspora mainly in New Zealand, the United States, and Australia).
- Recent outlook and risks:
  - Economy recovering after the 2022 Hunga Tonga-Hunga Ha’apai volcanic eruption.
  - Authorities project FY2025 growth about 0.5 percent above staff projections.
  - Inflation retreated from a peak of 14.1 percent in September 2022 and is now persistently within NRBT’s reference rate of 5 percent, averaging around 4 percent y.o.y so far this year.
  - Major downside risks include supply-side constraints, geographic remoteness, emigration-driven labor losses, and frequent natural disasters (recent storm and flooding cited).
- Fiscal policy stance and strategy:
  - Authorities support the assessment of the appropriateness of the expansionary fiscal stance and are committed to fiscal consolidation that balances climate resilience needs, social programs, and development goals.
  - Medium-term fiscal strategy: create fiscal buffers and improve debt dynamics via enhancing domestic revenue collection and rationalizing public expenditure.
  - World Bank assisting with technical assistance on rationalizing tax exemptions.
  - Authorities optimistic about achieving requisite levels of donor financial support over the medium term given established ties and prior prudent economic management.
- Monetary and financial sector policies:
  - NRBT tightened policy in 2023 by increasing Statutory Reserve Deposit (SRD); excess liquidity limited immediate impact.
  - Inflation decline attributed to global factors, eased supply bottlenecks, and lower commodity prices.
  - Ongoing review of the NRBT Act informed by the 2021 Safeguards Assessment and TA to modernize mandates and safeguard independence.
  - Financial sector remains strong with high capitalization and liquidity; vulnerabilities localized; major banks are well-capitalized foreign subsidiaries.
  - AML/CFT strengthening continues with assistance from PFTAC.
- Structural reforms and priorities:
  - Priority to enhance resilience to natural disasters and embed climate resilience in public infrastructure.
  - FY2025 budget statement “Building the Foundations for Sector-Driven Economic Growth and Stability” aims to revitalize investments through three thematic areas with private sector collaboration.
  - National Financial Inclusion Strategy 2023–2027 launched.
  - Recognize need to address impediments to investment (land ownership, regulation, red tape, legal reform) and to continue anti-corruption and governance strengthening.
- Data and statistical capacity:
  - Authorities committed to strengthening statistical capacity, addressing data gaps, and improving quality and timeliness; welcome continued Fund CD support.

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

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1tonea2024001-print-pdf.pdf_