## Tonga—IMF Assessment Letter for the World Bank ## Source details **Canonical URL:** [Tonga—IMF Assessment Letter for the World Bank](https://www.imf.org/-/media/files/publications/pp/2020/english/ppea2020024.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2020/english/ppea2020024.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2020/english/ppea2020024.pdf.json) --- ### Recent Developments, Outlook and Risks - Tonga’s modest recovery from Cyclone Gita will be interrupted by the Covid-19 pandemic. - After a sharp drop in FY2018 due to Cyclone Gita, economic activity began normalizing in FY2019, largely due to reconstruction activities supported by remittances, and marine exports. - Growth is expected to drop sharply due to spillovers from a major Covid-19-induced contraction in economic activity in remitting countries. - These effects are likely to persist through at least the first half of FY2021 in line with current (albeit highly uncertain) expectations about the trajectory and global impact of the pandemic. - Beyond this period, growth is expected to recover to 3–4 percent in FY2022–2 3 in line with current expectations of a global recovery. - Reserves are likely to remain comfortable in the remainder of FY2020, mainly due to import compression. - Weak competitiveness, lower remittances, heavy debt repayments, and large import needs are likely to widen current account deficits over time, reducing reserve coverage to 3−4 months of imports by 2023, well below desirable coverage (6¾ months of imports) for disaster-prone countries. - Inflation is forecast to remain low due to weaker global food and fuel prices. - Tonga’s growth potential is low; without a concerted effort to boost private sector development, medium-term growth is expected to trend down to 1.8 percent. - Significant downside risks to growth include difficult external debt dynamics, natural disaster risks, loss of correspondent banking relationships due to AML/CFT-related weaknesses, a prolonged synchronized global slowdown, larger-than-expected impact of the Covid-19 pandemic, and large oil price volatility. ### Fiscal Policy — Assessment and Recommendations - The government has demonstrated a commendable commitment to fiscal consolidation; the budget surplus for FY2019 reflects continued strength in revenue collection and generally effective controls on current spending in line with the fiscal anchors adopted in 2017. - Underlying spending policies have shown weaknesses, namely cost overruns particularly on the wage bill, compensated by delays in maintenance spending. - Tonga’s overall risk of public and external debt distress remains high. - Debt repayments are expected to spike starting in 2024. - The present value of public debt-to-GDP ratio is expected to rise above the 70 percent debt-distress threshold in 2028−29 under current policies and financing commitments (although debt service indicators remain below the relevant ratios). - Without new grant financing commitments and/or additional fiscal adjustment, fiscal buffers and international reserves will need to be run down and additional debt incurred to service existing obligations, leading to an exploding medium-term debt path. - Long-term debt sustainability would hinge on continued donor grants inflows to finance substantial fiscal and external gaps, and fiscal adjustment. - Policy recommendations: - Higher and better-quality budget surpluses are needed to stabilize debt dynamics while improving climate-resilience. - The pandemic will make it difficult to build buffers in the near term; fiscal balances are projected to be in deficit in FY2020−21 to accommodate costs of containment and healthcare, and targeted support. - Fiscal adjustment of the order of 3½−4 percent of GDP per year on average is required during FY2022−24 to allow a buildup of adequate fiscal buffers for debt, emergencies and maintenance. - Measures to achieve adjustment include continuing planned revenue administration reforms, broadening the tax base, updating excise rates, and expediting climate- and development-related spending. - Curb and reorient current spending toward improving capacity by rationalizing civil service functions and staffing critical positions while gradually aligning compensation with market pay levels to reduce turnover. - Faster implementation of investments requires consistent prioritization, improved cross-governmental coordination, and more effective use of procurement. - Donor grant financing will be essential to fill the gap, as maybe asset sales. - Fiscal anchors on the wage bill and public debt to GDP ratios remain appropriate, but improvements in the debt management strategy are warranted. ### Private Sector Development - A lasting solution to Tonga’s fiscal and development challenges is to grow the small private sector. - Structural constraints continue to impede private sector development despite important progress. - Tonga performs well relative to comparators across many aspects of the business environment, but lags in registering property and the legal framework and processes for resolving insolvency. - Governance improvements remain possible, particularly regarding regulatory quality and enforcement, government effectiveness, and control of corruption. - Policy priorities to boost private and foreign investment: - Increase access to skilled labor by improving TVET programs and facilitating integration of SWP workers into higher value-added activities and female workers into the labor force. - Improve transparency and predictability of, and clarify ownership rights in, the land-lease market to boost investment and expand access to credit. - Strengthen climate-resilience, improve regulations (such as the 2018 Foreign Exchange Control Act and insolvency laws), deregulate protected sectors, and boost official capacity to raise productivity and attract investors. ### Monetary Policy - The monetary stance should stay supportive through the economic fallout of the pandemic. - Monetary policy has been appropriately accommodative thus far, given low inflation and the slow recovery. - The central bank stayed on hold, maintaining the monetary policy rate at zero percent and the statutory reserve deposit rate at 10 percent. - The supportive stance should be continued, since inflation is likely to remain low due to Tonga’s heavy import-reliance and current expectations of low global prices of food and fuel (the dominant components of the CPI basket). - The NRBT’s recent announcement of its readiness to provide liquidity to banks if needed is appropriate. ### Financial Stability - Bank balance sheets are strong and financial inclusion has been improving. - Banks withstood the economic devastation of the 2018 Cyclone Gita which caused damage of 38 percent of GDP. - Banks are profitable and well-capitalized, with declining non-performing loans due to loan write-offs and settlements. - Credit growth has moderated after several years of large increases due to delays and cancellation of projects and lower household demand because of stretched debt-servicing capacity. - Lending continues to be concentrated in the housing sector. - According to the National Reserve Bank of Tonga (NRBT), bank balance sheets should be resilient to the impact of the pandemic. - The NRBT’s willingness to ease liquidity and exchange restrictions if necessary should assist banks in navigating the pandemic. - Financial sector vulnerabilities need better understanding and closer monitoring; continued improvements in supervision and inclusion are required. - The NRBT is strengthening risk-based offsite supervision to complement onsite efforts. - New regulations came into effect in 2019 and others are being drafted or awaiting Cabinet decisions. - Financial supervision should continue to be upgraded and deepened to incorporate stress testing and closer monitoring of household leverage. - As the pandemic unfolds, vigilance is warranted regarding its impact and that of announced restructuring of loans on bank capital and liquidity buffers. - Improving financial literacy and awareness and strengthening institutions such as credit bureaus will help improve financial inclusion. - Given the importance of remittances for the economy and the financial system, the AML/CFT framework should be strengthened. ### Fund Relations - Tonga is a large recipient of IMF technical assistance, including from the Pacific Financial Technical Assistance Center (PFTAC). - Tonga is on a 24-month consultation cycle. - The last Article IV consultation was concluded by the Executive Board on January 17, 2018. - The most recent Article IV consultation mission took place between February 10−20, 2020. *IMF staff assessment — April 2, 2020* --- _Source: https://www.imf.org/-/media/files/publications/pp/2020/english/ppea2020024.pdf_