## _cr08261

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### Background and main findings
- Tonga’s economy showed resilience after the November 2006 riots, supported by policy response and strong remittances.
- Government reconstruction loans and the King’s coronation in August 2008 may provide additional growth stimulus.
- Global upswings in fuel and food prices intensified pressures on inflation and external reserves.
- Outward migration has been substantial; strong remittances are the key mitigating factor to external shocks.
- Near-term growth prospects are favorable, but risks remain, particularly from further hikes in world food and fuel prices.

### Main issues and policy rebalancing
- Adverse terms-of-trade shocks complicate delivery of low inflation, stable growth, and external stability.
- Authorities recognize the need to improve resilience by rebalancing the policy mix toward:
  - a tighter monetary stance,
  - fiscal prudence, and
  - increased exchange rate flexibility.

### Staff’s views and recommended policy mix
- Rebalancing would improve the macroeconomic framework to address rising inflation and external vulnerability.
- Fiscal recommendations:
  - A balanced budget in FY07/08 likely to be achieved; maintaining this stance in FY08/09 is crucial.
  - Maintain a balanced FY08/09 budget to share macroeconomic management burden and generate fiscal savings to buffer increases in debt service over the medium term.
  - Required actions: sustainable fiscal measures to further improve tax administration and rationalize capital spending in line with donor financing and Tonga’s implementation capacity.
  - Move toward a more orderly public wage policy to reduce fiscal vulnerability from ad hoc and large wage adjustments.
- Debt recommendations:
  - Joint WB/IMF Debt Sustainability Analysis suggests Tonga remains at a high risk of debt distress with the proposed reconstruction loan, mitigated by large remittance inflows.
  - Debt sustainability hinges on phased utilization of the loan in line with the medium-term fiscal framework, supporting capital projects that generate growth and employment.
  - Recommendation: rely as much as possible on donor grants for future development financing.
- Monetary and exchange rate recommendations:
  - Early actions to tighten monetary policy are warranted to anchor inflation expectations before finalization of the FY08/09 budget.
  - Monetary tightening should be achieved through effective, market-based instruments, including issuance of central bank notes.
  - Rebalancing the policy mix would support increased exchange rate flexibility to safeguard reserves, keep inflation under control, and help correct a likely modest overvaluation of the pa’anga over the medium term.

### Authorities’ views
- Broad agreement with staff assessments and policy requirements.
- Authorities aim at a balanced budget and will take additional measures if needed.
- Monetary authorities acknowledged inflation has exceeded their comfort zone of single digit levels and are committed to tightening monetary policy, if necessary.
- Authorities noted the magnitude of exchange rate depreciation will be carefully considered because of its inflationary impact.

### Economic and policy developments (selected observations)
- Real GDP:
  - Real GDP contracted by about 3¼ percent in FY06/07 (following ¾ percent growth a year earlier).
  - Preliminary indicators for the first half of FY07/08 suggest recovery led by the services sector; agriculture continues to contract.
- Inflation:
  - CPI inflation rose to 12½ percent at end-March 2008 (from 6¾ percent at end-December 2007).
  - Domestic CPI inflation shows a modest rising trend; monetary easing in early 2007 may have contributed.
  - Public wage settlement impact partially offset by retrenchment of about 20 percent of total civil service workers.
- External position:
  - Current account deficit in FY07/08 projected to remain at about 10 percent of GDP.
  - External reserves declined to around 3-months of imports and are likely to continue downward toward end-FY07/08 reflecting recent fuel price hikes.
- Monetary aggregates:
  - Private sector credit growth: 16½ percent (y/y) at end-February 2008, from 6½ percent at end-March 2007.
  - Banks’ business loans grew to almost 30 percent by end-December 2007.
  - Excess liquidity rose to over 30 percent of reserve money in early 2008, then declined to around 10 percent in recent months; drawdown largely used to finance oil imports with a corresponding decline in NFA of the NRBT.

### Outlook and risks
- Near term:
  - Real GDP projected to expand by 1¼ percent in FY07/08.
  - Inflation expected to remain high at above 10 percent over the next few months due to pass-through of higher fuel and food prices and modest depreciation of the pa’anga.
- Medium term:
  - Real GDP growth expected to reach 2¾ percent in FY08/09 as reconstruction activity gains momentum.
  - Growth projected to return to long-run average of 1¾ percent over the medium term.
  - Inflation expected to trend downward as world fuel and food prices are projected to stabilize over the medium term (based on WEO assumptions).
- Risks:
  - Near-term upside: King’s coronation in August 2008 could stimulate growth via remittances, hotel occupancy, and consumption.
  - Near-term downside: further increases in fuel and food prices could entrench high inflation and intensify external vulnerability; coronation could lead to budget spending overruns.
  - Medium-term downside: continued adverse terms-of-trade shocks, reemergence of wage pressures, and constitutional reform tensions beginning in 2010.

### Fiscal policy and public wage issues
- FY07/08:
  - A balanced budget in FY07/08 is likely through buoyant revenue, recovery of arrears, and containment of the public wage bill and nonwage spending.
- FY08/09 challenges:
  - Authorities proposed a balanced FY08/09 budget, but achieving it will be challenging without new measures.
  - Budget proposes over 20 percent growth in tax revenue to support higher maintenance and capital spending.
  - Measures in the budget include:
    - reduction in maximum tariff rate to 20 percent (from 45 percent),
    - lifting individual income tax exemption threshold to TOP7,400 (from TOP2,500),
    - reduction in corporate tax rate for large taxpayers.
- Wage policy specifics:
  - The wage bill is large by regional standards; orderly public wage adjustments recommended:
    - annual wage adjustments broadly in line with inflation,
    - limited public hiring,
    - gradual decompression of the public wage structure,
    - formulation of public wage adjustments within a medium-term fiscal framework.
- Box 1 — Civil Service Wage Settlement numeric points:
  - 60–80 percent wage increase agreed in September 2005; FY05/06 increase to be paid in two phases during FY05/06 and FY06/07.
  - Government voluntary redundancy program in April–June 2006 reduced personnel by 18 percent.
  - Total cost of the wage settlement: about 9 percent of GDP in FY05/06, and 3¾ percent in FY06/07.
  - Wage bill projected to increase to 13¾ percent of GDP in FY07/08 from a pre-settlement level of 11¾ percent in FY04/05.
  - Number of civil servants (memorandum): 4,563; 4,422; 3,615.
  - Wage and salaries expenditure (2007/08 Prel. Proj., in millions of pa'anga): 49.7; 90.5; 80.0; 76.7.
  - Wage and salaries expenditure (In percent of GDP): 11.7; 19.1; 16.2; 13.8.

### Monetary policy, exchange rate, and external viability
- Monetary assessment:
  - Monetary easing in early 2007 was appropriate given low inflation; shift toward monetary tightening is warranted as the economy recovers and inflation rises.
  - Early monetary actions needed to anchor inflation expectations ahead of finalizing the FY08/09 budget to minimize wage pressures, prevent entrenchment of high inflation, and help contain liquidity pressure on the balance of payments.
- Recommended instruments and limits:
  - Achieve tightening through effective, market-based instruments, including issuance of NRBT notes and increases in reserve requirements.
  - Limit reliance on administrative controls such as credit ceilings.
- Financial stability and NRBT role:
  - NRBT could step up prudential measures to monitor fast growth in business loans.
  - Amendments to the NRBT Act (approved by parliament in August 2007) will help enhance NRBT’s capital base and clarify profit transfer rules.
- Exchange rate assessment:
  - Staff analysis: REER appears broadly in line with fundamentals, but quantitative estimates point to a likely overvaluation of 5–10 percent.
  - Quantitative estimates:
    - MB approach: REER overvaluation estimated at 3½ percent in 2006/07.
    - ERER approach: overvaluation of about 10 percent.
    - ES approach: REER would need to depreciate by 8½ percent to stabilize banking system NFA at end-2006/07 level (17 percent of GDP).
  - Recent movements:
    - Pa’anga depreciated by 2¼ percent in nominal effective terms in 2007 against a weighted basket of major currencies, while it appreciated by 5 percent vis-à-vis the U.S. dollar.
    - In real effective terms, the pa’anga appreciated by 1¾ percent.
- Policy recommendation:
  - Rebalance policy mix to support increased exchange rate flexibility.
  - Near-term policy flexibility implies a modest depreciation of the pa’anga to speed balance of payments adjustment and reduce import-driven reserve pressures.
  - Increased exchange rate flexibility within the monthly adjustment band recommended to correct likely modest overvaluation and ensure external stability.
- Authorities’ stance:
  - Authorities noted remittances support nearly 80 percent of imports and expect imports to decline in event of remittance slowdown.
  - Authorities agreed that a prudent fiscal stance and further monetary tightening should permit NRBT increased exchange rate flexibility.

### Debt sustainability, reconstruction loan, and financing strategy
- China reconstruction loan:
  - Agreement with China’s EXIM Bank signed in November 2007 for a RMB 440 million reconstruction loan, currently valued at about US$63 million (23 percent of GDP), at 2 percent and 20-year maturity, with a grace period of five years.
  - Initial plan to disburse over FY08/09–FY09/10; disbursements postponed as private sector has taken lead.
  - Government reassessing funding requirements and preparing a better-defined framework for loan use.
- DSA findings and illustrative scenario:
  - LIC DSA indicates PPG external debt dynamics are manageable given positive dynamics over the projection period under baseline assumptions.
  - DSA assumes utilization of US$10 million of the reconstruction loan per year over FY08/09–FY12/13.
  - Due to low exports, NPV of external debt and debt service-to-exports ratios are projected to exceed or be close to thresholds of 100 percent and 15 percent, indicating a high risk of debt distress; this risk is significantly mitigated by large remittance inflows.
  - Remittances have grown to reach seven times the value of exports in 2007.
- Risks of rapid disbursement:
  - If the reconstruction loan is disbursed in large sums over the next two years as initially planned, debt service could jump to over 1 percent of GDP and 3 percent of projected reserves starting in FY13/14, intensifying external debt distress risks.
- Public debt projections and thresholds:
  - External debt level: declined to 40½ percent of GDP in FY06/07 from 42½ percent of GDP in FY05/06; over 80 percent of external debt is on concessional terms.
  - Under baseline:
    - NPV of PPG external debt projected to increase by about 5 percent of GDP to 38 percent of GDP by FY12/13.
    - NPV of PPG external debt projected to decline to 16½ percent of GDP by FY27/28.
  - Indicative thresholds (LIC DSA for Tonga as poor performer):
    - NPV of external debt: 30 percent of GDP
    - NPV of external debt: 100 percent of exports
    - NPV of external debt: 200 percent of revenues
    - Debt service: 15 percent of exports; 25 percent of revenues
  - Status: NPV-of-debt to GDP and NPV-of-debt to exports remain above country-specific indicative thresholds for a prolonged period under baseline.
- Staff policy guidance:
  - Limit use of nonconcessional financing for future development programs.
  - Rely on donors’ grants and long-term concessional financing.
  - Prioritize projects consistent with donor grants, concessional resources, and implementation capacity; broaden private sector role.
  - Fiscal prudence, export diversification, improved tourism, and policies to enhance growth prospects are critical for medium-term debt sustainability.
- Authorities’ views:
  - Authorities broadly agreed with the DSA and are reviewing the size and business needs of the reconstruction loan, potentially leading to a significantly smaller disbursement over a longer horizon.
  - Donors plan to step up grant financing over the next 2–3 years, but capacity to fully utilize grants needs improvement.

### Structural reform, governance, and capacity building
- Shoreline renationalization:
  - Deloitte and Touche estimated Shoreline’s value at US$21 million in March 2007; with an additional US$5 million administrative fee, total cost could be nearly 10 percent of GDP or 59 percent of reserves.
  - Government considering using foreign exchange proceeds from sale of Westpac Bank of Tonga to finance this transaction, potentially in second half of FY07/08.
  - Staff recommendations:
    - Seek potential investors to acquire Shoreline; consider delaying payments associated with the transaction until Shoreline is sold to private investors.
    - Avoid financing repurchase using foreign exchange proceeds that could undermine NRBT objectives.
- Governance and administrative impediments:
  - Tonga’s governance indicators (World Bank, 2006) perceived as weaker than regional peers; impediments include restrictions on business licensing, land issues, and immigration visas.
  - Recent improvements: Procurement Bill passed in late 2006; preparations to outsource certain government operations starting FY08/09; training on corporate governance and compliance; task forces on land, immigration visa, and business licensing; Independent Anti-Corruption Commission granted legal enforcement power.
  - Staff recommendations: implement Procurement Bill, convert task force outcomes into concrete, monitorable measures; improve public discussion and timely dissemination of information.
- Statistical capacity and technical assistance:
  - Improving statistical capacity remains a priority; national accounts and price statistics identified as priorities.
  - Recommendation: seek further technical assistance and work closely with PFTAC and AsDB.

### Staff appraisal: summary judgments and recommended priorities
- Economy recovering from November 2006 riots but adverse terms-of-trade shocks have added inflation and balance of payments pressure.
- Policy mix recommendations:
  - Rebalance policy mix: tighter monetary stance and sound fiscal framework to contain inflation, while facilitating greater exchange rate flexibility.
  - Early monetary tightening warranted, particularly ahead of finalizing the FY08/09 budget; use market-based instruments and limit reliance on credit ceilings.
  - Monitor high credit growth to the business sector to ensure financial stability.
- Fiscal recommendations:
  - Balanced budget for FY08/09 appropriate; require limiting new public hiring, containing nonwage spending, and improving tax administration.
  - Improve expenditure management; prioritize capital projects in line with donor grants and implementation capacity.
  - Use the Expenditure Review Committee to conduct quarterly budget reviews to minimize fiscal slippage.
  - Aim for small budget surpluses over the medium term to buffer future debt service increases.
- Exchange rate and reserves:
  - Exchange rate broadly in line with fundamentals but quantitative estimates point to a likely modest overvaluation correctable under the current regime.
  - A modest depreciation of the pa’anga may be required in the near term to speed balance of payments adjustment and contain reserve pressures; improved policy mix would permit this while keeping inflation expectations under control.
- Exchange restriction:
  - Authorities plan to retain an exchange restriction in the form of a tax certification requirement applied to various current international transactions.
  - The Board approved this restriction until July 9, 2008 or the 2008 Article IV consultation, whichever is earlier.
  - In absence of a firm timetable for removal, staff does not propose further approval of this restriction.

### Debt sustainability — detailed baseline assumptions and quantitative points
- Baseline assumptions:
  - Real GDP growth projected to average 1¾ percent over 2007/08–2012/13; projection includes transitory reconstruction stimulus then return to historical average of 1½ percent.
  - Inflation (GDP deflator) projected to average around 8 percent over 2007/08–2012/13; in U.S. dollar terms GDP deflator inflation projected to average around 4 percent.
  - Fiscal balance projected to achieve a virtual balance during 2007/08–2008/09 and small surpluses over 2009/10–2012/13.
  - Current account deficit projected to narrow to about 7 percent of GDP over the medium term (from 10 percent of GDP in 2007/08).
  - Reconstruction financing baseline: soft-loan of about $10 million per year disbursed over 2008/09–2012/13; cumulative disbursement about $50 million of the $63 million loan.
- Key macro numeric projections and series cited in Box 1 (selection):
  - Real GDP growth (in percent): projected average 1.8 (series includes 0.6, -3.2, 1.9, 3.0, 1.2, 2.6, 1.9, 1.8, 1.6, 1.6, 1.8, 1.6, 1.6, 1.6).
  - GDP deflator in US dollar terms (change in percent): series includes 7.1, 7.6, 2.2, 11.2, 5.6, -2.5, 4.8, 5.0, 4.4, 4.0, 3.6, 2.3, 2.3, 2.2.
  - Effective interest rate (percent): series includes 1.9, 1.7, 1.4, 0.4, 2.0, 2.0, 1.8, 1.6, 1.5, 1.4, 1.7, 1.7, 1.7, 1.7.
  - Growth of exports of goods & services (US dollar terms, in percent): series includes 2.6, -19.8, -1.2, 21.3, 21.0, 13.0, 6.8, 6.8, 6.2, 5.7, 9.9, 4.0, 4.0, 3.9.
  - Growth of imports of goods & services (US dollar terms, in percent): series includes 11.7, -6.1, 6.9, 17.1, 19.1, 12.4, 6.8, 1.8, 6.2, 5.7, 8.7, 4.0, 4.0, 3.9.
  - Memorandum item — Nominal GDP (millions of US dollars): series includes 236.2, 246.0, 263.0, 263.2, 280.9, 300.1, 318.6, 336.8, 490.5, 596.4.

### Key macroeconomic figures and recommendations for the Article IV cycle
- Nominal GDP (2006/07): US$ 246.0 million
- Population (2007): 102,360
- GDP per capita (2006/07): US$ 2,433
- Remittances: described as “very high” and “over 30 percent of GDP”; main source of foreign exchange earnings.
- Gross official foreign reserves: 46.0 (millions of U.S. dollars) in latest reported year in tables.
- Reserves in months of imports: reported values include 4.8, 3.7, 3.1, 3.9, 3.0, 2.8 (various years).
- Consumer prices (end of period) examples: 11.7, 9.7, 7.0, 5.1, 14.5, 12.3 (annual series) and projections 4.8, 4.2 (medium-term projections).
- Recommendation: next Article IV consultation with Tonga takes place on a standard 12-month cycle.

*Italic: IMF staff report — Executive Summary, _cr08261_*

### Executive Summary ......................................................................................................

### _cr08261 - Executive Summary ......................................................................................................

### Background and main findings
- Tonga’s economy has shown resilience after the November 2006 riots, with policies and strong remittances underpinning the recent recovery.
- Government reconstruction loans and the King’s coronation in August 2008 may provide additional growth stimulus.
- Global upswings in fuel and food prices have intensified pressures on inflation and external reserves.
- Outward migration has been substantial; strong remittances are the key mitigating factor to external shocks.
- Near-term growth prospects are favorable, but risks remain, particularly from further hikes in world food and fuel prices.

### Main issues
- Adverse terms-of-trade shocks complicate economic management aimed at delivering low inflation and stable growth while safeguarding external stability.
- Authorities recognize the need to improve Tonga’s resilience to external shocks by rebalancing the policy mix toward:
  - a tighter monetary stance,
  - fiscal prudence, and
  - increased exchange rate flexibility.

### Staff’s views and recommended policy mix
- Rebalancing the policy mix would improve the macroeconomic framework to address concerns of rising inflation and external vulnerability.
- Fiscal:
  - A balanced budget in FY07/08 is likely to be achieved; maintaining this stance in FY08/09 is crucial.
  - Maintaining a balanced FY08/09 budget is necessary to share macroeconomic management burden and generate fiscal savings to buffer increases in debt service over the medium term.
  - Required actions: sustainable fiscal measures to further improve tax administration and rationalize capital spending in line with donor financing and Tonga’s implementation capacity.
  - Move toward a more orderly public wage policy to reduce fiscal vulnerability from ad hoc and large wage adjustments.
- Debt:
  - The joint WB/IMF Debt Sustainability Analysis suggests that with the proposed reconstruction loan, Tonga remains at a high risk of debt distress, mitigated by large remittance inflows.
  - Debt sustainability hinges on phased utilization of the loan in line with the medium-term fiscal framework, supporting capital projects that generate growth and employment.
  - Recommendation: rely as much as possible on donor grants for future development financing.
- Monetary and exchange rate:
  - Early actions to tighten monetary policy are warranted to anchor inflation expectations before finalization of the FY08/09 budget.
  - Monetary tightening should be achieved through effective, market-based instruments, including issuance of central bank notes.
  - Rebalancing the policy mix would support increased exchange rate flexibility to safeguard reserves, keep inflation under control, and help correct a likely modest overvaluation of the pa’anga over the medium term.

### Authorities’ views
- Broad agreement with staff assessments and policy requirements.
- Authorities aim at a balanced budget and will take additional measures if needed to ensure the target is met.
- Monetary authorities acknowledged inflation has exceeded their comfort zone of single digit levels and are committed to tightening monetary policy, if necessary, to safeguard reserves and contain inflation.
- Authorities noted the magnitude of exchange rate depreciation will be carefully considered because of its inflationary impact.

### Introduction (context and constraints)
- Output was severely disrupted in FY06/07 after the November 2006 riots.
- Private investment has been the key factor underpinning resilience; donor-supported reconstruction loans and the King’s coronation in August 2008 may add momentum.
- Tonga relies heavily on imports (mostly food and fuel); export base is narrow; trade balance is highly vulnerable to external price shocks.
- Real GDP growth averaged 1.9 percent over the past decade, underperforming most other Pacific Island countries.
- Key structural impediments: high costs of labor and energy, limited export diversification, and lack of long-term investment to improve productivity and efficiency.

### Economic and policy developments (selected observations)
- Real GDP:
  - Real GDP contracted by about 3¼ percent in FY06/07 (following ¾ percent growth a year earlier).
  - Preliminary indicators for the first half of FY07/08 suggest recovery led by the services sector; agriculture continues to contract.
- Inflation:
  - CPI inflation rose to 12½ percent at end-March 2008 (from 6¾ percent at end-December 2007).
  - Domestic CPI inflation shows a modest rising trend; monetary easing in early 2007 may have contributed.
  - Public wage settlement impact on inflation partially offset by retrenchment of about 20 percent of total civil service workers.
- External position:
  - Current account deficit in FY07/08 projected to remain at about 10 percent of GDP.
  - External reserves declined to around 3-months of imports and are likely to continue downward toward end-FY07/08 reflecting recent fuel price hikes.
- Monetary aggregates:
  - Private sector credit growth: 16½ percent (y/y) at end-February 2008, from 6½ percent at end-March 2007.
  - Banks’ business loans grew to almost 30 percent by end-December 2007.
  - Excess liquidity rose to over 30 percent of reserve money in early 2008, then declined to around 10 percent in recent months; drawdown largely used to finance oil imports with a corresponding decline in NFA of the NRBT.

### Outlook and risks (near-term and medium-term)
- Near term:
  - Real GDP projected to expand by 1¼ percent in FY07/08 (recovery in private domestic demand; external demand contribution remains negative).
  - Inflation expected to remain high at above 10 percent over the next few months due to pass-through of higher fuel and food prices and modest depreciation of the pa’anga.
- Medium term:
  - Real GDP growth expected to reach 2¾ percent in FY08/09 as reconstruction activity gains momentum.
  - Growth projected to return to long-run average of 1¾ percent over the medium term.
  - Inflation expected to trend downward as world fuel and food prices are projected to stabilize over the medium term (based on WEO assumptions).
- Near-term risks:
  - Upside: King’s coronation in August 2008 could stimulate growth via remittances, hotel occupancy, and consumption.
  - Downside: further increases in fuel and food prices could entrench high inflation and intensify external vulnerability; coronation could lead to budget spending overruns.
- Medium-term risks:
  - Untapped growth potential in tourism; remittances could be channeled to productive investment for export diversification.
  - Competition in tourism from better-developed destinations (e.g., Fiji).
  - Continued adverse terms-of-trade shocks and reemergence of wage pressures threaten fiscal and external sustainability.
  - Tonga’s constitutional reform toward a democratic system could potentially spark tensions when the process begins in 2010.

### II. Policies to improve resilience and sustain recovery — A. Ensuring fiscal prudence
- FY07/08:
  - A balanced budget in FY07/08 is likely to be achieved through buoyant revenue, recovery of arrears, and containment of the public wage bill and nonwage spending.
- FY08/09 challenges:
  - Authorities proposed a balanced FY08/09 budget, but achieving it will be challenging without new measures.
  - Budget proposes over 20 percent growth in tax revenue to support higher maintenance and capital spending.
  - Measures in the budget include:
    - reduction in maximum tariff rate to 20 percent (from 45 percent),
    - lifting individual income tax exemption threshold to TOP7,400 (from TOP2,500),
    - reduction in corporate tax rate for large taxpayers.
- Staff recommendations:
  - Maintain fiscal prudence to share macroeconomic management burden and generate fiscal savings for medium-term debt service.
  - Implement sustainable fiscal measures: further improve tax administration and rationalize capital spending consistent with Tonga’s implementation capacity and availability of nondebt generating financing.
  - Maintain momentum in tax revenue collection; contain contingency fund allocations; rationalize capital spending priorities.

### II. Policies to improve resilience and sustain recovery — A. Ensuring fiscal prudence (wage policy)
- The wage bill is large by regional standards; a more orderly public wage adjustment process is important to reduce fiscal vulnerability.
- A sustainable wage structure could include:
  - annual wage adjustments broadly in line with inflation,
  - limited public hiring,
  - gradual decompression of the public wage structure to retain high-skilled workers,
  - formulation of public wage adjustments within a medium-term fiscal framework.

Box 1 — The Civil Service Wage Settlement (key numeric points)
- 60–80 percent wage increase agreed in September 2005; the FY05/06 increase to be paid in two phases during FY05/06 and FY06/07.
- Government carried out voluntary redundancy program in April–June 2006, reducing personnel by 18 percent.
- Total cost of the wage settlement, including one-off payments such as severance package, accounts for about 9 percent of GDP in FY05/06, and 3¾ percent in FY06/07.
- Wage bill projected to increase to 13¾ percent of GDP in FY07/08 from a pre-settlement level of 11¾ percent in FY04/05.
- Number of civil servants (memorandum): 4,563; 4,422; 3,615 (periods indicated in source table).
- Wage and salaries expenditure (2007/08 Prel. Proj., in millions of pa'anga): 49.7; 90.5; 80.0; 76.7 (source table entries).
- Wage and salaries expenditure (In percent of GDP): 11.7; 19.1; 16.2; 13.8 (source table entries).
- The Box emphasizes the need for an orderly wage-setting mechanism and support from labor unions and civil servants for reform.

### II. Policies to improve resilience and sustain recovery — B. Moving toward monetary tightening and improved exchange rate flexibility
- Background:
  - Monetary policy was eased in several steps in early 2007 to support recovery; the impact began to materialize recently.
- Monetary indicators:
  - Private sector credit growth: 16½ percent (y/y) at end-February 2008, from 6½ percent at end-March 2007.
  - Banks’ business loans: almost 30 percent by end-December 2007.
  - Excess liquidity: over 30 percent of reserve money in early 2008; declined to around 10 percent in recent months.
- Staff view:
  - Early tightening warranted to anchor inflation expectations.
  - Use effective, market-based instruments (including central bank notes) to tighten policy.
  - Increased exchange rate flexibility would help safeguard reserves and contain inflation, and address a likely modest overvaluation of the pa’anga.

*Italic: IMF staff report — Executive Summary, _cr08261_*

### 12.      Monetary easing in early 2007 was appropriate to revive the economy at a time

### _cr08261 - 12.      Monetary easing in early 2007 was appropriate to revive the economy at a time

### Monetary policy: assessment and recommendations
- Early monetary easing in 2007 was appropriate given low inflation; a shift toward monetary tightening is warranted as the economy recovers and inflation rises.
- Early monetary actions are needed to anchor inflationary expectations in advance of the finalization of the FY08/09 budget to:
  - minimize wage pressures;
  - prevent high inflation from becoming entrenched;
  - help contain liquidity pressure on the balance of payments.
- Recommended instruments and limits:
  - Achieve monetary tightening through effective, market-based instruments, including the issuance of NRBT notes and increases in reserve requirements.
  - Limit reliance on administrative controls, such as credit ceilings.
- Financial stability risks and NRBT role:
  - NRBT could step up prudential measures to monitor fast growth in business loans, as continued rapid growth could pose risks to financial stability, especially in an environment of low growth that could undermine business and households’ debt servicing capacity.
  - Amendments to the NRBT Act, approved by parliament in August 2007, will help enhance the NRBT’s capital base, strengthen its accountability in bank operations, and clarify its profit transfer rules.

### Authorities’ views on monetary policy
- The authorities are committed to tighten monetary policy if necessary to safeguard reserves and contain inflation, supported by a balanced budget.
- Monetary actions guided by two key considerations:
  - maintaining reserves at a minimum of three months of imports; and
  - keeping inflation under control.
- The authorities acknowledged that inflation is already running at above their comfort zone of single digit levels and are closely monitoring external developments, particularly oil payments and remittances, as both items have significant but offsetting implications for reserves.
- NRBT views:
  - NRBT concurred that relying on market-based instruments is desirable.
  - Issuance of NRBT notes will only be efficient if there is excess liquidity in the system.
  - Achieving monetary tightening beyond that stage may require other instruments, including statutory reserve requirements and credit ceilings, to contain credit growth.
  - Continued reliance on NRBT notes at that stage may increase costs for the NRBT and undermine its financial soundness.

### Improving external viability: background and assessment
- Staff analysis:
  - Tonga’s REER appears broadly in line with economic fundamentals, although quantitative estimates point toward a likely overvaluation that could be corrected within the adjustment band under the current exchange rate regime. Results are subject to considerable uncertainty due to significant data deficiencies.
  - Recent balance of payments dynamics appear sustainable, although trade performance warrants close monitoring in light of a sustained rise in international fuel and food prices.
  - In the absence of further major external shocks, the current account deficit as a share of GDP is expected to narrow significantly over the medium term as fuel and food prices stabilize; under this scenario, reserves should remain at around three months of imports.
  - Progress with banks to reduce transaction costs for remittances should support continued strong inflows; remittances help reduce external vulnerability.
  - External vulnerability could be aggravated by further increases in food and fuel prices.
- Quantitative REER assessments:
  - Quantitative assessments indicate a likely overvaluation of 5–10 percent, which could be corrected within the monthly adjustment band under the current exchange rate regime.
  - Under a modified Macroeconomic Balance (MB) approach, REER overvaluation is estimated at 3½ percent in 2006/07.
  - The equilibrium real exchange rate (ERER) approach suggests an overvaluation of about 10 percent.
  - The external sustainability (ES) approach suggests the REER would need to depreciate by 8½ percent to stabilize the NFA of the banking system at its end-2006/07 level (17 percent of GDP).
- Recent exchange rate movements:
  - The NRBT made little use of exchange rate flexibility since 2003.
  - The pa’anga depreciated by 2¼ percent in nominal effective terms in 2007 against a weighted basket of major currencies, while it appreciated by 5 percent vis-à-vis the U.S. dollar.
  - In real effective terms, the pa’anga appreciated by 1¾ percent, reflecting mainly inflation rate differentials with Tonga’s trading partners.

### Policy issues and staff views on external sector
- Historical REER movements:
  - Following a depreciation of about 9 percent during 1997–2003, the REER appreciated by 13 percent over 2003–07, reflecting mainly externally driven higher inflation in Tonga relative to trading partners.
- External price competitiveness:
  - External price competitiveness does not seem an immediate concern; Tonga’s exports remain small (less than one-tenth of imports).
  - Squash, Tonga’s major export product, is confined to a niche market in Japan with competitiveness influenced by local production patterns, quarantine standards, and bilateral preferential tariff treatment.
  - Current currency basket weights remain broadly in line with Tonga’s currency composition of trade, provided export revenues are augmented with remittance receipts (viewed as derived from service exports of human capital).
- Policy recommendation:
  - Rebalance the policy mix to support increased exchange rate flexibility to safeguard reserves while keeping inflation expectations under control.
  - Near-term policy flexibility would imply a modest depreciation of the pa’anga given current reserves and strong import demand to speed up balance of payments adjustment and reduce import-driven reserve pressures.
  - Increased exchange rate flexibility within the monthly adjustment band would help correct a likely modest overvaluation of the pa’anga and ensure external stability.
- Authorities’ stance:
  - Authorities agreed recent balance of payments dynamics do not indicate large exchange rate misalignment; remittances support nearly 80 percent of imports.
  - Authorities expect that in the event of a slowdown in remittances, imports would decline accordingly.
  - Authorities emphasized the current exchange rate regime could provide sufficient flexibility to adjust a possible overvaluation if needed.
  - Authorities noted magnitude of exchange rate depreciation will be carefully considered given its inflationary impact but agreed that a prudent fiscal stance and further monetary tightening should allow NRBT increased exchange rate flexibility.

### Ensuring debt sustainability: background and staff views
- China reconstruction loan:
  - Agreement with China’s EXIM Bank signed in November 2007 for a RMB 440 million reconstruction loan, currently valued at about US$63 million (23 percent of GDP), at 2 percent and 20-year maturity, with a grace period of five years.
  - Initial plan was to disburse over FY08/09–FY09/10 for reconstruction of Nuku’alofa, but disbursements postponed as private sector has taken a significant lead.
  - Government is reassessing funding requirements and working on a better-defined framework for loan use.
- DSA findings and illustrative scenario:
  - LIC DSA suggests Tonga’s public and publicly guaranteed external (PPG) debt is manageable given positive debt dynamics over the projection period.
  - DSA assumes utilization of US$10 million of the reconstruction loan per year over FY08/09–FY12/13, with GDP growth at historical average and fiscal consolidation.
  - Reflecting Tonga’s low exports, NPV of external debt and debt service-to-exports ratios are projected to exceed or be close to thresholds of 100 percent and 15 percent, indicating a high risk of debt distress; this risk is significantly mitigated by large remittance inflows.
  - Remittances have grown to reach seven times the value of exports in 2007 and are the main source of foreign exchange earnings.
- Risks of rapid disbursement:
  - If the reconstruction loan is disbursed in large sums over the next two years as initially planned, debt service could jump to over 1 percent of GDP and 3 percent of projected reserves starting in FY13/14 (after a five-year grace period), intensifying external debt distress risks.
- Policy guidance:
  - Limit use of nonconcessional financing for future development programs.
  - Rely as much as possible on donors’ grants, supplemented by long-term concessional financing; reliance on nonconcessional external borrowing is highly discouraged.
  - Prioritize development projects consistent with donor grants, concessional resources, and implementation capacity; broaden private sector role in project implementation.
  - Fiscal prudence, export diversification, improved tourism, and policies to enhance growth prospects are critical for medium-term debt sustainability.
- Authorities’ views:
  - Authorities broadly agreed with DSA assessment and are reviewing the size and business needs of the reconstruction loan, potentially leading to a significantly smaller disbursement over a longer horizon.
  - Donors plan to step up grant financing over the next 2–3 years, but capacity to fully utilize grants needs improvement.
  - Strengthened policy framework and strong remittances should help improve debt servicing capacity.

### Structural reform and capacity building
- Corporatization and privatization progress but pressure to repurchase Shoreline (private power company currently owned by the King) has increased.
  - Deloitte and Touche estimated Shoreline’s value at US$21 million in March 2007; combined with an additional US$5 million administrative fee, total value could cost the government nearly 10 percent of GDP or 59 percent of reserves.
  - Government considering using foreign exchange proceeds from sale of Westpac Bank of Tonga to finance this transaction, potentially in second half of FY07/08.
- Governance and administrative impediments:
  - Tonga’s governance indicators (World Bank, 2006) perceived as weaker than regional peers; administrative impediments include restrictions on business licensing, land issues, and immigration visas.
  - Recent improvements: Cabinet passed the Procurement Bill in late 2006; preparations underway to outsource certain government operations starting in FY08/09; training on corporate governance and compliance; task forces on land, immigration visa, and business licensing; Independent Anti-Corruption Commission granted legal enforcement power.
- Staff recommendations on Shoreline and governance:
  - Concern that repurchase of Shoreline could be fiscally large and undermine NRBT objectives if financed using foreign exchange from Westpac sale.
  - Government should seek potential investors to acquire Shoreline; consider options to delay payments associated with the transaction until Shoreline is sold to private investors.
  - Implement measures to address administrative impediments and increase transparency; implement Procurement Bill and convert task force outcomes into concrete, monitorable measures; improve public discussion and timely dissemination of information.
- Authorities’ views:
  - Authorities will seek transparency in any repurchase of Shoreline and consider options to minimize fiscal burden; search for potential investors given priority.
  - Need to update Governance Indicators for Tonga; government ready to work with donors to monitor Procurement Bill implementation and improve transparency.

### Staff appraisal: summary judgments and recommended policy mix
- Economic context:
  - Tonga’s economy is recovering from the November 2006 riots, but adverse terms-of-trade shocks have contributed to inflation and balance of payments pressures.
- Policy mix recommendations:
  - Improve resilience to external shocks through a rebalanced policy mix: tighter monetary stance and sound fiscal framework to contain inflation, while facilitating greater exchange rate flexibility amid external pressure.
  - Early monetary tightening warranted to anchor inflationary expectations, particularly ahead of finalizing the FY08/09 budget; use effective, market-based instruments and limit reliance on credit ceilings.
  - Closely monitor high credit growth to the business sector to ensure financial stability; review extent of monetary tightening on a timely basis to avoid entrenching inflation.
- Fiscal recommendations:
  - A balanced budget for FY08/09 is appropriate; achieving this requires limiting new public hiring, containing nonwage spending, and improving tax administration.
  - Improve expenditure management, prioritize capital projects in line with donor grants and nonconcessional financing, and match projects to implementation capacity.
  - Use the Expenditure Review Committee to conduct quarterly budget reviews to minimize fiscal slippage.
  - Over the medium term, fiscal framework should aim at small budget surpluses to buffer future debt service increases, underpinned by tax administration reform and orderly public wage policy.
- Exchange rate and reserves:
  - Exchange rate broadly in line with fundamentals but quantitative estimates point to a likely modest overvaluation correctable under current regime.
  - Given current reserves and rising import demand, a modest depreciation of the pa’anga may be required in the near term to speed balance of payments adjustment and contain reserve pressures; improved policy mix would permit this while keeping inflation expectations under control.
- Exchange restriction:
  - Authorities plan to retain exchange restriction in the form of a tax certification requirement applied to various current international transactions.
  - The Board approved this restriction until July 9, 2008 or the 2008 Article IV consultation, whichever is earlier.
  - In the absence of a firm timetable for removal of this restriction, staff does not propose further approval of this restriction.

*IMF staff report excerpt.*

### 38.      Tonga’s medium-term debt sustainability hinges on the strength of fiscal

### 38.      Tonga’s medium-term debt sustainability hinges on the strength of fiscal

### Debt sustainability and financing
- Findings:
  - Tonga’s public debt dynamics show that donor grants and long-term concessional loans are the preferred form of financing.
  - Recourse to nonconcessional borrowing should be avoided.
  - The reconstruction loan of US$63 million puts Tonga over the external debt distress thresholds over the medium term, suggesting a high risk of distress.
  - Remittances play an important role in significantly mitigating external debt and debt service risks.
- Policy guidance:
  - Keep annual disbursement of the reconstruction loan to levels consistent with Tonga’s medium-term fiscal framework and implementation capacity.
  - Prioritize securing nondebt-creating flows (donor grants) and long-term concessional financing.
  - Maintain a sound public debt management policy.
  - Support export diversification and increased tourism to enhance debt sustainability.

### Shoreline renationalization and associated financial transactions
- Findings and recommendations:
  - The government’s plan to temporarily renationalize Shoreline should be carefully reviewed and articulated to the public.
  - Make every effort to seek potential investors interested in acquiring the company in the near future.
  - Consider options to delay payments associated with the underlying financial transaction by the government until Shoreline is sold to private investors.

### Governance and transparency
- Findings:
  - Progress has been made, including Cabinet approval of a Procurement Bill to be implemented in FY08/09.
  - Land, immigration visa, and business licensing issues continue to deter investment and have given rise to public perceptions of weak governance.
- Recommendations:
  - Further address land, immigration visa, and business licensing issues to encourage investment.
  - Improve public discussion of policies and timely dissemination of information to enhance transparency and communicate policy intentions.

### Statistical capacity and technical assistance
- Findings:
  - Improving statistical capacity remains a priority.
  - The authorities have identified the national accounts and price statistics as priorities in need of technical assistance.
- Recommendations:
  - Seek further technical assistance in statistics.
  - Work closely with PFTAC and AsDB to review existing technical assistance programs to address national accounts and price statistics needs.

*From: _cr08261 - 38.*

### 42.      It is recommended that the next Article IV consultation with Tonga takes place on a

### _cr08261 - 42.      It is recommended that the next Article IV consultation with Tonga takes place on a

### Recommendation on Article IV consultation
- It is recommended that the next Article IV consultation with Tonga takes place on a standard 12-month cycle.

### Economic context and key macroeconomic figures
- Nominal GDP (2006/07): US$ 246.0 million
- Population (2007): 102,360
- GDP per capita (2006/07): US$ 2,433
- Remittances: described as “very high” and “over 30 percent of GDP”; identified as the largest source of foreign exchange earnings.
- Gross official foreign reserves: 46.0 (millions of U.S. dollars) in latest reported year in tables.
- Reserves in months of imports: reported values include 4.8, 3.7, 3.1, 3.9, 3.0, 2.8 (various years in tables).
- Consumer prices (end of period) reported in Table 1 and projections: examples include 11.7, 9.7, 7.0, 5.1, 14.5, 12.3 (annual series) and projected path 4.8, 4.2 (medium-term projections).

### Baseline assumptions used in the DSA
- Real GDP growth assumed at historical average: 1.8 (baseline) and 1.6 (10-year average) and 1.9 (historical average) as shown in Tonga: Baseline Vis-a-Vis 10-year Average.
- Reconstruction loan utilization in baseline: $50 million over FY08/09–FY12/13, with even disbursement of $10 million per year and repayments after a five-year grace period.
- Baseline assumes no other major external nonconcessional borrowing.
- Baseline assumption on net private transfer receipts: climb to an average 45½ percent of GDP over the projection period from a historical average of 33½ percent.

### External Debt Sustainability (External DSA) — findings
- External debt level: declined to 40½ percent of GDP in FY06/07 from 42½ percent of GDP in FY05/06; over 80 percent of external debt is on concessional terms.
- Under baseline:
  - NPV of PPG external debt projected to increase by about 5 percent of GDP to 38 percent of GDP by FY12/13.
  - NPV of PPG external debt projected to decline to 16½ percent of GDP by FY27/28.
- Indicative thresholds (LIC DSA for Tonga as poor performer):
  - NPV of external debt: 30 percent of GDP
  - NPV of external debt: 100 percent of exports
  - NPV of external debt: 200 percent of revenues
  - Debt service: 15 percent of exports; 25 percent of revenues
- Status relative to thresholds:
  - NPV-of-debt to GDP and NPV-of-debt to exports remain above country-specific indicative thresholds for a prolonged period under baseline.
  - NPV-of-debt and debt service-to-revenue ratios remain well below their respective indicative thresholds of 200 percent and 25 percent over the projection period.
  - NPV of PPG external debt-to-exports ratio projected to exceed the indicative threshold of 100 percent, reflecting very low exports.
- Key vulnerabilities from scenario analysis and stress tests:
  - High sensitivity to negative shocks to remittances and exports.
  - Increased nonconcessional borrowing would raise risk; limiting nonconcessional borrowing is important.

### Public Debt Sustainability — findings
- Total public sector debt stock: declined to 45¼ percent of GDP in FY06/07 from 48½ percent of GDP in FY05/06.
- Under baseline:
  - Total NPV of public debt projected to increase by 5 percent of GDP by 2012/13 (to 43 percent of GDP).
  - Total NPV of public debt projected to gradually decline to about 18 percent of GDP over the longer run.
  - Domestic public debt projected to fall to below 6 percent of GDP by 2012/13 and less than 1 percent of GDP by 2027/28.
- Key risks:
  - Growth shocks could lead to sharp deterioration in debt burden indicators.
  - If debt-creating flows increase, or if the primary fiscal deficit returns to its historical average of 0.6 percent of GDP, public debt dynamics would worsen.
  - Full or rapid disbursement of the reconstruction loan (e.g., full disbursement in FY08/09–09/10) remains a major downside risk.

### Staff assessment and overarching conclusions
- Tonga remains at a high risk of external debt distress under the LIC DSA baseline.
- Very high remittance inflows (over 30 percent of GDP) provide a countervailing effect that helps mitigate liquidity risks and reduce immediate external vulnerability.
- Public sector debt indicators are elevated in the short term but show a decreasing trend over the longer run under the baseline.
- Managing the use and disbursement profile of the nonconcessional reconstruction loan is crucial to improving medium-term debt dynamics.

### Policy recommendations and priorities
- Limit utilization of the nonconcessional reconstruction loan and lengthen its disbursement horizon.
- Increase donor grant and concessional financing to support reconstruction and future development needs.
- Maintain fiscal prudence and strengthen fiscal consolidation to limit domestic budget financing and support debt sustainability.
- Adopt policies to enhance growth prospects and export diversification to reduce vulnerability associated with low exports.
- Prioritize public investment projects that generate high growth and employment to strengthen future debt-service capacity.
- Implement a sound public debt policy, aligned with the medium-term fiscal framework, to guide future development financing decisions.

*Source: Data and analysis as presented in the IMF/World Bank Joint Debt Sustainability Analysis 2008 and the IMF staff report tables and figures supplied by the Tongan authorities.*

### Box 1. Baseline Assumptions

### Box 1. Baseline Assumptions

### Real GDP growth
- Real GDP growth is projected to average 1¾ percent over the period 2007/08–2012/13.
- This projection reflects a transitory growth stimulus spurred by reconstruction activity in the capital city over the first two years, and a return to a historical average of 1½ percent thereafter.
- The long-run growth outlook is described as conservative and reflects structural impediments which continue to constrain Tonga’s growth potential.

### Inflation and exchange-rate effects
- Inflation, as measured by the GDP deflator, is projected to average at around 8 percent over the projection period of 2007/08–2012/13, reflecting partial pass through of world food and fuel price increases assumed by the WEO.
- In U.S. dollar terms, GDP deflator inflation is projected to average around 4 percent over the same period, reflecting modest depreciation of the pa’anga against the U.S. dollar.

### Fiscal outlook and public finances
- The fiscal balance is projected to achieve a virtual balance during 2007/08–2008/09 and small surpluses over 2009/10–2012/13, based on the authorities’ stated objectives to limit domestic financing of the budget.
- In the long run:
  - Tax revenue is projected to stabilize near its historical average of around 32 percent of GDP.
  - Total expenditure is projected to come slightly below its historical average of 32 percent of GDP through a modest containment of the wage bill in real terms.
  - This implies a fiscal surplus of ¼ percent of GDP in the long run to build fiscal savings.

### External sector, remittances, and reserves
- The current account deficit is projected to narrow to about 7 percent of GDP over the medium term and stabilize around that level thereafter (from 10 percent of GDP in 2007/08).
- The export base is projected to remain narrow and relatively undiversified, while strong remittance inflows are expected to continue.
- Growth of imports is projected to moderate markedly as reconstruction-related imports subside and world food and fuel prices stabilize.
- The outlook for net foreign direct investment remains favorable, broadly in line with the past five-year average of 5½ percent of GDP.
- Official foreign reserves are projected to remain comfortable in terms of import cover.

### Reconstruction financing (baseline illustrative scenario)
- Reconstruction financing under the baseline represents an illustrative scenario where a soft-loan of about $10 million per year would be disbursed over a five-year period during 2008/09–2012/13.
- The cumulative loan disbursement of about $50 million represents a plausible upper bound on the utilization of the $63 million reconstruction loan over the next five years.
- Loan terms: interest rate of 2 percent; maturity of 20 years; 5-year grace period.

### Key macroeconomic assumptions (selected projections and averages reported in the box)
- Real GDP growth (in percent): projected average 1.8 (table entries show series including 0.6, -3.2, 1.9, 3.0, 1.2, 2.6, 1.9, 1.8, 1.6, 1.6, 1.8, 1.6, 1.6, 1.6).
- GDP deflator in US dollar terms (change in percent): series includes 7.1, 7.6, 2.2, 11.2, 5.6, -2.5, 4.8, 5.0, 4.4, 4.0, 3.6, 2.3, 2.3, 2.2.
- Effective interest rate (percent): series includes 1.9, 1.7, 1.4, 0.4, 2.0, 2.0, 1.8, 1.6, 1.5, 1.4, 1.7, 1.7, 1.7, 1.7.
- Growth of exports of goods & services (US dollar terms, in percent): series includes 2.6, -19.8, -1.2, 21.3, 21.0, 13.0, 6.8, 6.8, 6.2, 5.7, 9.9, 4.0, 4.0, 3.9.
- Growth of imports of goods & services (US dollar terms, in percent): series includes 11.7, -6.1, 6.9, 17.1, 19.1, 12.4, 6.8, 1.8, 6.2, 5.7, 8.7, 4.0, 4.0, 3.9.
- Grant element of new public sector borrowing (in percent): series includes 44.7, 29.2, 41.6, 41.8, 42.0, 42.2, 40.2, 56.9, 56.9, 56.9 (reported in table).
- Grant-equivalent financing (in percent of GDP): series includes 3.0, 4.7, 6.9, 6.8, 6.6, 6.6, 4.6, 4.5, 4.7 (reported in table).
- Memorandum item — Nominal GDP (millions of US dollars): series includes 236.2, 246.0, 263.0, 263.2, 280.9, 300.1, 318.6, 336.8, 490.5, 596.4.

*Source: Staff simulations and projections as presented in the IMF informational annex (Box 1: Baseline Assumptions).*

### ANNEX III. TONGA: RELATIONS WITH THE WORLD BANK GROUP

### ANNEX III. TONGA: RELATIONS WITH THE WORLD BANK GROUP

### Membership and IDA Allocation
- Since becoming a World Bank Group member in 1985, Tonga has received a total of five IDA credits totaling SDR 15.2million (original amount USD equivalent of 22.8 million).
- Tonga is eligible for an IDA 14 allocation of SDR 4.2 million (indicative only) over FY2006–08.

### Key Components of the Bank’s Current Program in Tonga
- Health
  - Tonga Health Sector Support Project (USD10.9 million credit approved in mid-2003).
  - Objectives: support the Government in improving the performance of its health sector through appropriate health financing policy, revised health information systems, and improved management and infrastructure of the country's main hospital.
  - Status: Construction of the hospital has been satisfactorily completed. Health financing policy has been developed and mechanisms of implementation are being finalized.

- Natural Hazard Management
  - Cyclone Emergency Recovery and Management Project, with an IDA credit of US$5.9 million approved in 2002.
  - Purpose: assist Tonga in replacing and strengthening the resilience of social infrastructure and help upgrade Tonga’s emergency and risk management capacity to cope better with future disasters and the risk posed by climate change.

- Education System
  - Tongan Education Support Project with an IDA credit of US$1.0 million and an NZAID trust fund of US$4.1 million (managed by the Bank) approved in June 2005.
  - School grants fund:
    - Phase 1: nearly all schools received grants on a capitation basis and spent over 80% of the funds on educational materials and maintenance.
    - Successfully evaluated; lessons learned will be addressed in the second phase.
  - IDA Credit Agreement amended in January 2008 to allocate IDA funding to the third phase of the school grants program in 2009 (at the request of the Government of Tonga).

- Financial Management and Procurement
  - An IDF grant of US$200,000 approved in December 2003 to support public procurement reforms and procurement capacity building through technical assistance.
  - A draft Procurement Law, prepared by the government-appointed consultant and based on the UNCITRAL Model Law, has been reviewed by the Bank; comments were provided to the Government.
  - Revision being undertaken by the Ministry of Finance (MoF) and Crown Law.
  - Implementation for activities 2 and 3 (manual, standard bidding documents and training) is under way as MoF has appointed an individual consultant to provide assistance.

- Transport Sector Reform
  - Bank completed a Transport Sector Review Study to support the Government’s commitment to improve the structure and efficiency of the sector, including assessing options for sustainable financing.
  - A study of opportunities for public-private partnership in the airport sector was completed in April 2006, leading to the corporatization of the airport on a business basis.
  - Bank preparing a lending program to help the Ministry of Transport consolidate recent laws, realign its functions, and improve inter-island ferry services (the project is scheduled to go to the board on June 26, 2008).
  - Tentative follow up Tonga Transport project for FY11 which will draw upon the findings of a planned study on infrastructure needs (supported by the new Pacific Regional Infrastructure Facility).

- Private Sector Development
  - Active BEE program through the trilaterally funded (IFC, FIAS, World Bank) Tonga Implementation of Regulatory Reform Program (US$700,000 over two years).
  - A draft MoU for a new BEE project is with the Ministry of Finance for review; the project will build upon work from Tonga Regulatory Reform Phase II.
  - Under the previous project a Taskforce for the Implementation of Regulatory Reform was established in January 2006, overseeing four public-private Working Groups: Starting a Business; Licenses and Permits; Fishing (tax focus); and Immigration.
  - Taskforce membership: four Ministers and four senior private sector representatives; mandate is to identify and remove regulatory impediments to private sector growth.

### Recent Reports and Policy Notes
- East Asia and Pacific Update: Testing Times Ahead, April 2008
- At Home and Away–Expanding Job Opportunities for Pacific Islanders through Labor Mobility, August 2006
- Opportunities to Improve Social Services: Human Development in the Pacific Islands, 2006
- The Pacific Infrastructure Challenge, 2006
- Not If, But When: Adapting to Natural Hazards in the Pacific Islands Region, 2006
- Pacific Regional Strategy FY2006-2009, May 2005

### World Bank Credits (in millions of U.S. dollar equivalent, as of May 16, 2008)
- Total disbursed 22.1
- Undisbursed 5.84

*Prepared by World Bank staff. (As of May 2008)*

### ANNEX IV. TONGA: RELATIONS WITH THE ASIAN DEVELOPMENT BANK

### ANNEX IV. TONGA: RELATIONS WITH THE ASIAN DEVELOPMENT BANK

### AsDB strategic alignment and objectives
- The Asian Development Bank (AsDB) strategy for Tonga supports the Government’s Strategic Development Plan Eight 2006/07–2008/09 (SDP-8) development goals.
- Government strategic objectives emphasized in SDP-8:
  - average budget deficit less than 2 percent of GDP
  - inflation below 7 percent
  - GDP growth in the 3–4 percent range
  - reduction in the poverty headcount index below 23 percent
  - development driven mainly by the private sector and an efficient public sector

- The Country Partnership Strategy (CPS) 2007–2012 for Tonga:
  - Will support SDP-8 implementation in alignment with the objectives of the 2005 Paris Declaration on Aid Effectiveness.
  - Focuses on poverty reduction through three intervention pillars:
    - pro-poor, environmentally sustainable integrated urban infrastructure development
    - financing of pro-poor policies through effective, prudent macroeconomic and fiscal management
    - private sector development
  - Capacity strengthening and institution building are key expected outcomes.
  - CPS outcomes expected:
    - (i) improved fiscal governance
    - (ii) improved social services delivery in urban areas
    - (iii) an improved private sector-enabling environment

### AsDB operations, financing, and technical assistance
- Cumulative approvals since 1972:
  - AsDB has approved 15 loans totaling $57.8 million from the Asian Development Fund (ADF) to Tonga since it joined AsDB in 1972.
  - Fifty-four technical assistance projects with a value of $15.3 million were also provided.
- Past investment focus:
  - Finance development and infrastructure development in transport, power, agriculture, and fisheries.
- Recent and active portfolio (as of February 2008):
  - Active projects include five TAs in the country portfolio.
  - The latest loan on Economic and Public Sector Reform was completed successfully in 2004.
  - The five ongoing TAs focus on:
    - public enterprise reforms
    - youth micro-enterprise development
    - preparing the integrated urban development projects
    - support for the implementation of SDP-8
    - Rationalization of Public Enterprises, Phase III
  - A regional TA on strengthening pro-poor policy in the Pacific for Tonga for $0.2m has been implemented on a regional basis and is counted as country TA; it supported economic sector work and some work is being prepared to complete that work.

### Loan and technical assistance approvals, 2002–06 (annual details)
- Loan approvals:
  - 2002: Number 1; Amount (in millions of U.S. dollars) 10
  - 2003: Number 0; Amount 0
  - 2004: Number 0; Amount 0
  - 2005: Number 0; Amount 0
  - 2006: Number 0; Amount 0

- Technical assistance approvals:
  - Number by year:
    - 2002: 1
    - 2003: 3
    - 2004: 3
    - 2005: 1
    - 2006: 2
  - Amount (in millions of U.S. dollars) by year:
    - 2002: 0.7
    - 2003: 0.9
    - 2004: 0.7
    - 2005: 0.7
    - 2006: 0.9

### Expected CPS results and institutional emphasis
- Expected results from the results-based CPS:
  - Improved fiscal governance
  - Improved social services delivery in urban areas
  - Improved private sector enabling environment
- Capacity strengthening and institution building are identified as among the key outcomes.

*Prepared by Asian Development Bank staff. (As of February 2008).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08261.pdf_