## _cr10112

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---

### Economic developments
- Activity:
  - GDP contracted in FY2008/09 (year ending in June) as the global crisis lowered both tourist arrivals and remittances inflows; banks contracted lending; part of the Tongan archipelago was hit by a tsunami on September 29, 2009 causing loss of life and significant material damage.
  - Recent trend: the economy appears to be bottoming out as capital spending plans are implemented and financial conditions ease.
- Inflation:
  - Consumer price inflation fell to 1½ percent year-on-year in January 2010, reflecting lower global fuel and commodity prices.
- External position:
  - Current account deficit widened due to lower remittances and exports.
  - Reserves have risen this year as a result of the recent SDR allocation and the disbursement of donor grants and loans to reconstruct the Central Business District.
- Key historic figures:
  - Real GDP growth: 2006/07: -1.2 percent; 2007/08: 2.0 percent; 2008/09: -0.4 percent.
  - Inflation (annual): 2006/07: 5.6 percent; 2007/08: 12.2 percent; 2008/09: 1.2 percent.
  - Current account (percent of GDP): 2006/07: -8.4; 2007/08: -9.0; 2008/09: -14.3.
  - Gross reserves (US$ millions): 2006/07: 47.1; 2007/08: 48.2; 2008/09: 67.7.
  - Real effective exchange rate (+ = appreciation): 2006/07: -0.1; 2007/08: 2.3; 2008/09: 5.5.

### Outlook and risks
- Near-term outlook:
  - Staff expects activity to fall in FY2009/10 by ½ percent given delays in implementation of capital projects and the low domestic value added content of spending linked to the China reconstruction loan.
  - Growth should rebound to 1¾ percent in FY2010/11, boosted by increased construction activity; tourism and remittances should begin to pick up slowly.
  - Inflation will rise in coming months and end FY2009/10 at around 4 percent.
- Medium-term prospects and constraints:
  - Public infrastructure spending provides a temporary boost in FY2010/11; once projects wind down, achieving growth even in the 1–2 percent range will be challenging.
  - Constraints: geographic isolation, narrow export base, high cost of labor, inability to retain skilled labor, impediments to private sector activity.
- Balance of risks:
  - Tilted to the downside: faltering global recovery; further rise in world commodity and food prices; Tonga’s high public debt.
  - Political risk: elections scheduled for November 2010 may slow reforms and lead to increased fiscal spending; decisions on a new electoral system and legislative composition are pending.

### Remittances (Box I: Determinants of Remittance Flows to Tonga)
- Role and magnitude:
  - Remittances account for over 67 percent of imports on average and are the main source of foreign exchange.
  - Tonga is the leading recipient of remittances relative to GDP among Pacific island countries.
  - In 2009, 17 percent of remittances were sent to nonprofit organizations (mostly churches).
- Use and volatility:
  - Mostly used to finance consumption; originate mainly from the United States, New Zealand, and Australia.
  - Volatility: remittances are 40 percent less volatile than exports.
- Empirical determinants (regression coefficients and standard errors):
  - Change in Exchange Rate (one-period lag): coefficient -0.295*** (standard error 0.038).
  - One-period Lagged Change in Remittances: coefficient -1.486** (standard error 0.608).
  - Change in Real GDP Growth in Remitting Countries (one-period lag): coefficient 0.097*** (standard error 0.009).
  - Unemployment Rate in Remitting Countries (one-period lag): coefficient -0.038 (standard error 0.034).
  - Interest rate differential (one-period lag): coefficient 0.025*** (standard error 0.007).
- Interpretation:
  - Remittance growth falls with an appreciating currency, increases with higher GDP growth in remitting countries and with the interest rate differential; Tongans abroad do not fully compensate for exchange rate movements.

### Calibrating macroeconomic policies

Fiscal policy — background, stance, and guidance
- FY2009/10 fiscal stance:
  - Deficit expected to rise to 4 percent of GDP (from 3¼ percent of GDP in the previous fiscal year) reflecting a 10 percent hike in civil servant wages, higher infrastructure spending, and weak revenues (revenues fell short of budget forecasts by about 6 percent of GDP).
  - Authorities introduced an end-of-year cap on spending across line ministries and requested additional budget-support grants; if requested funds are allocated this fiscal year, the estimated fiscal deficit would be around 2½ percent of GDP.
- Public debt:
  - Marked increase primarily reflects two renminbi loans from China’s EXIM bank with a face value totaling over 30 percent of GDP.
  - Tonga placed in the range of “high risk of debt distress”; government bears all credit and currency risk associated with on-lending of these loans to private parties.
  - Further government borrowing, even on concessional terms, should be avoided.
- Policy guidance and targets:
  - Limit growth in total employee compensation to below the level of CPI inflation.
  - Carefully prioritize current spending and improve tax administration.
  - Staff expect to limit the deficit to around 5 percent of GDP in the near term with a pickup in activity, continued grant support, and strengthened revenue administration.
  - Medium term: aim for a primary surplus target of around 1 percent of GDP.
  - Continued grant support from donors of the order of 3½ percent of GDP per year required; should grants be lower, reductions and reallocations will be necessary.
- Revenue administration improvements:
  - Progress: issuing unique tax identification numbers to corporate taxpayers; introducing self-assessment for personal and corporate income tax; automating customs processing.
  - Staff recommended increasing resources for tax and customs administration to strengthen auditing and tax collection.

Monetary and exchange rate policy (staff advice)
- Recent central bank actions:
  - NRBT lowered reserve requirements from 10 to 5 percent; reduced repo rate from 10 to 4½ percent; suspended issuance of central bank bills.
- Near-term stance:
  - Maintain a neutral monetary policy stance in the months ahead; begin withdrawing monetary stimulus once recovery in trading partners is firmly established.
  - If inflation risks or downward pressures on reserves materialize, withdraw stimulus on an accelerated timetable.
- Operational tools and observed developments:
  - Use full range of instruments and flexibility afforded by the exchange rate arrangement to contain inflation and maintain adequate reserves.
  - Authorities favor higher reserve requirements and direct limits on credit growth if tightening needed.
  - Nominal exchange rate broadly stable against the currency basket; real effective exchange rate has appreciated.
- Reserve posture:
  - Authorities aim to ensure foreign reserves remain at comfortable levels of 3−4 months of imports.
  - Staff assessed the pa’anga as moderately overvalued; NRBT should be ready to gradually depreciate against the basket if balance of payments pressures emerge, accompanied by fiscal restraint.
  - NRBT to reassess weights in the currency basket; PFTAC to provide technical assistance.

Financial sector and prudential policy
- Banking sector:
  - Banks’ balance sheets weakened due to worsening credit quality; provisioning increased.
  - Banks improving risk management practices; most credit-related losses frontloaded; banks expected to return to profitability by the second half of the year.
- Supervisory recommendations:
  - Step up prudential regulations and supervision, increase frequency of on-site visits, and improve prudential reporting.
  - Encourage disclosure to customers about full costs of new loans.
  - Resist political pressure to administer deposit and lending rates; maintain market-determined rate setting.

Structural policy priorities to promote private-sector-led growth
- Constraints: geographic isolation, narrow export base, high labor costs, inability to retain skilled labor, impediments to private sector activity.
- Recommendations:
  - Strengthen institutional framework for secured lending and creditor rights.
  - Improve legal framework for collateralized borrowing; consider centralized credit bureau; enact secured property and bankruptcy protection laws.
  - Rationalize public enterprises, modernize commercial legal framework, increase access to land (extend leases to over 99 years), reduce business licensing burdens, and lower barriers to foreign investment.
  - Improve utility efficiency and reduce utility costs.

### Fiscal management and medium-term budgeting (section 12)
- Current constraints:
  - Fiscal decision-making hampered by limited economic and policy analysis and an inadequate budget reporting system; reporting by line ministries and inter-agency communication need improvement.
- Recommended framework and actions:
  - Adopt a medium-term framework anchored by a fiscal-deficit path that achieves sustainable debt levels.
  - Integrate annual budget, line ministries’ spending plans, and the National Strategic Planning Framework (NSPF).
  - Improve fiscal control through more frequent monitoring and better use of electronic monitoring systems.
- Implementation support:
  - Authorities committed to reforms over the next two years with technical assistance from ADB and PFTAC.
- Debt and on-lending risks:
  - Establish a comprehensive debt management strategy; exercise care in selecting private sector projects receiving on-lent funds.
  - Authorities recognized risks and requested IMF technical assistance to strengthen debt management capacity.

### Near-term outlook and inflation (section 23 highlights)
- Growth and inflation:
  - Growth should reach 1¾ percent in FY2010/11.
  - Inflation should end the year at around 4 percent.
- Banking and credit:
  - With recapitalization of banks and most losses realized, lending could resume; ample liquidity exists in the banking system.
- Monetary risks and triggers:
  - Risk that liquidity overhang could translate into higher credit growth, higher inflation, worsening current account, and downward pressure on reserves.
  - Triggers for tightening: higher-than-expected inflation or downward pressures on reserves.
  - Tools: raise reserve requirements, resume issuance of central bank paper, raise repo rates; limit direct credit controls to minimize distortions.

### Debt vulnerabilities, DSA findings, and stress tests (Annex V and related sections)
- Overall judgment:
  - Tonga remains at a high risk of debt distress.
- Key drivers of higher near-term debt:
  - Recently contracted Y291 million ($42½ million) China EXIM bank loan for road construction; two China Exim Bank reconstruction loans with face values totaling over 30 percent of GDP.
- Public sector debt dynamics:
  - Total public sector debt stock rose substantially in FY2008/09 and FY2009/10, reaching over 50 percent of GDP.
  - Domestic debt projected at around 7¼ percent of GDP by June 2010; outstanding government bonds expected at 4¼ percent of GDP by end-June.
- DSA baseline projections and targets:
  - Primary surpluses of around 1 percent of GDP assumed over the medium term.
  - PPG external debt currently over 30 percent of GDP; PV of PPG external debt projected to increase to about 42 percent of GDP by 2011/12 before declining under the threshold by 2017/18 and to around 8 percent of GDP by 2030.
  - External current account deficit projected to reach 20 percent of GDP in 2011/12, then return to around 10½ percent of GDP over the medium term.
- Debt burden relative to exports and remittances:
  - PV of PPG external debt-to-exports ratio well over two-and-a-half times the 100 percent threshold and projected to remain above threshold well past 2020.
  - When remittances are included, PV of PPG debt projected to exceed 100 percent in 2010–12 and remain above the modified threshold until around 2013/14.
- Stress-test results (selected):
  - Export shock: PV of debt exceeds 500 percent of exports and stays >10 percent above the 100 percent threshold for the entire projection period; debt service to exports ratios rise above the 15 percent threshold, reaching over 30 percent in 2015.
  - One-time 30 percent depreciation: PV of debt rises to around 60 percent of GDP and remains persistently above the 30 percent threshold even after 2020; PV of debt-to-revenue ratio persistently breaches its threshold.
  - Public sector DSA: NPV of public debt builds to almost 50 percent of GDP in 2011/12 before declining under the baseline.
- Policy implication:
  - Sustained fiscal consolidation, donor support, careful management of liabilities, and prioritization of projects with high growth and employment returns are needed to mitigate vulnerabilities.

### Key macroeconomic and fiscal statistics (selected, as reported)
- Nominal GDP (2008/09): US$ 328.4 million.
- Population (2006): 101,991.
- GDP per capita (2008/09): US$ 3,220.
- Quota: SDR 6.9 million.
- Real GDP growth (2006/07–2008/09): -1.2 percent; 2.0 percent; -0.4 percent.
- Consumer prices (period average, 2005/06–2010/11 series excerpt): 7.0; 5.1; 9.8; 5.0; 2.2; 4.2.
- Government finance (percent of GDP highlights):
  - Total revenue and grants (2005/06–2010/11 series): 26.6; 28.3; 26.3; 24.0; 25.3; 29.2.
  - Total expenditure and net lending (2005/06–2010/11 series): 29.4; 27.3; 24.7; 27.3; 29.2; 34.3.
  - Overall balance (percent of GDP): -2.8; 1.1; 1.5; -3.3; -3.9; -5.1.
- Money and banking (selected levels and growth):
  - Total liquidity (annual percent change series): 13.3; 13.3; 6.7; -1.1; 4.3; 1.4.
  - Broad money (M2, annual percent change series): 16.6; 11.9; 8.2; -1.8; 2.0; 2.5.
  - Net foreign assets (millions of pa'anga end-period): 73.2; 81.9; 80.5; 117.6; 123.3; 136.2.
- Balance of payments (selected):
  - Current transfers (net, millions of U.S. dollars): 88.9; 84.2; 94.7; 75.8; 59.1; 66.7.
  - Current account balance (millions of U.S. dollars): -22.8; -25.5; -30.9; -46.9; -51.5; -60.5.
  - Gross official foreign reserves (millions of U.S. dollars): 40.4; 47.1; 48.2; 67.7; 70.6; 72.0.
  - In months of imports: 3.1; 3.9; 3.2; 4.7; 5.3; 4.8.
- External debt (percent of GDP): 29.0; 27.1; 25.3; 31.5; 44.2; 50.7.
- Public sector debt (percent of GDP selected series): 37.3; 33.9; 38.6; 51.4; 57.1; 58.5; 55.8; 51.6; 47.6; 36.3; 16.1.

### PFTAC engagement and statistical/technical assistance (Annex II and Annex V)
- PFTAC assistance to Tonga since 2006: 27 advisory missions; Tonga sent 63 officials to regional seminars/workshops and organized six attachments up to March 2010; scoping mission on Medium Term Budgeting scheduled for late March 2010.
- Public Financial Management support:
  - Assistance on midyear economic review, fiscal update, GFSM 2001 presentation, revenue estimation, and feasibility of long-term Financial and Economic Management Program.
- Tax administration:
  - Passage of new Income tax and Customs Acts (self-assessed); post implementation review of VAT; consumption tax introduced in 2005 helped increase tax revenues.
  - Trade liberalization revenue risk estimated externally as high as 27 percent of total revenue.
- Banking supervision:
  - BCP assessment in 2002 led to enhanced Financial Institutions Act enacted in late 2004; further TA on on-site examinations and prudential reporting; NRBT Act amendments awaiting Parliament.
- Statistics improvements:
  - National accounts rebased (new series released June 2009; retains 2000/01 base); balance of payments revised to BPM5; MFS reporting improved with SRFs published in March 2008 IFS; further work on BOP, NAS, and producer price indexes undertaken with PFTAC/STA assistance.
- Data gaps and needs:
  - Long delays in data provision; weak source data for national accounts; CPI basket based on 2000/01 HIES; employment statistics not compiled since 2003.

### Policy recommendations (condensed)
- Fiscal:
  - Move near-term fiscal stance toward neutral; limit growth in employee compensation to at most CPI inflation; prioritize spending; step up revenue administration and expenditure control.
  - Establish a comprehensive medium-term fiscal strategy and debt management strategy; aim for medium-term primary surplus of around 1 percent of GDP; avoid new borrowing.
  - Continue donor grant support of about 3½ percent of GDP per year; if lower, reallocate and cut lower-priority spending.
- Monetary and exchange rate:
  - Maintain neutral monetary stance; withdraw stimulus once recovery in trading partners is firm; tighten if inflation or reserve pressures materialize using reserve requirements, central bank paper, and repo rates.
  - Use exchange rate flexibility; stand ready to gradually depreciate against the basket if needed, accompanied by fiscal restraint.
- Financial sector and legal reforms:
  - Strengthen bank supervision and disclosure; improve legal framework for collateralized lending; consider centralized credit bureau; enact secured property and bankruptcy laws.
  - Resist administered interest rates to avoid credit rationing.
- Structural:
  - Advance NSPF priorities: private sector growth, infrastructure maintenance, technical and vocational education, health (non-communicable diseases), environmental sustainability.
  - Improve business environment: increase access to land, reduce licensing, narrow prohibitions on foreign investment, and improve utility efficiency.

### Institutional and surveillance notes
- Fund relations (as of March 31, 2010):
  - Membership Status: Joined September 13, 1985; Article VIII.
  - Quota: 6.90 SDR Million.
  - Total holdings of currency: 5.19 (75.20 percent of quota); Reserve position in Fund: 1.71 (24.81 percent of quota).
  - SDR Department net cumulative allocation: 6.58 (100 percent); Holdings: 7.07 (107.48 percent).
  - Outstanding Purchases and Loans: None; Financial Arrangements: None.
  - Exchange rate arrangement: pa’anga value determined on a weighted basket of the United States, Australian, New Zealand dollars (U.S. dollar as intervention currency); Japanese yen added in July 2000; monthly maximum adjustment limit raised to 5 percent.
- Recommendation:
  - It is recommended that the next Article IV consultation take place on a standard 12-month cycle.

*IMF staff executive summary as presented in the source document.*

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

### _cr10112 - Executive Summary ......................................................................................................

### Economic Developments
- Activity: GDP contracted in FY2008/09 (year ending in June) as the global crisis lowered both tourist arrivals and remittances inflows; banks contracted lending; part of the Tongan archipelago was hit by a tsunami on September 29, 2009 causing loss of life and significant material damage.
- Recent trend: The economy appears to be bottoming out as capital spending plans are implemented and financial conditions ease.
- Inflation: Consumer price inflation fell to 1½ percent year-on-year in January 2010, reflecting lower global fuel and commodity prices.
- External position:
  - The current account deficit has widened due to lower remittances and exports.
  - Reserves have risen this year as a result of the recent SDR allocation and the disbursement of donor grants and loans to reconstruct the Central Business District.

### Outlook and Risks
- Near-term outlook:
  - Staff expects activity to fall in FY2009/10 by ½ percent given delays in the implementation of capital projects and the low domestic value added content of spending linked to the China reconstruction loan.
  - The economy should grow faster in the next fiscal year, driven by increased construction activity and the global recovery.
  - Inflation will rise in the coming months reflecting stronger domestic demand and a recent increase in electricity prices, but still end FY2009/10 at around 4 percent.
- Medium-term prospects:
  - Public infrastructure spending should provide a temporary boost to activity in FY2010/11, but once those projects wind down it will be challenging to achieve growth even in the 1–2 percent range.
  - Constraints include geographic isolation, narrow export base, high cost of labor, inability to retain skilled labor, and impediments to private sector activity.
- Risks:
  - A faltering global recovery would directly weaken remittances, tourism, and exports, further weakening domestic activity and the balance of payments.
  - A further rise in world commodity and food prices would hit Tonga via higher inflation, weaker growth, and a larger current account deficit.
  - Tonga’s high public debt poses a major risk to economic prospects.
  - Political risk: Elections scheduled for November 2010 may slow reforms and lead to increased fiscal spending; decisions on a new electoral system and legislative composition are pending.

### Remittances (Box I: Determinants of Remittance Flows to Tonga)
- Role of remittances:
  - Remittances account for over 67 percent of imports on average.
  - Remittances are the main source of foreign exchange and Tonga is the leading recipient of remittances relative to GDP among Pacific island countries.
  - In 2009, 17 percent of remittances were sent to nonprofit organizations (mostly churches).
- Use and volatility:
  - Remittances are mostly used to finance consumption and originate mainly from the United States, New Zealand, and Australia.
  - Remittances have a volatility that is 40 percent lower than that of exports; they are a more reliable source of foreign exchange than exports.
- Empirical determinants (regression results reported):
  - Change in Remittances regressed on:
    - Change in Exchange Rate (one-period lag): coefficient -0.295*** (standard error 0.038).
    - One-period Lagged Change in Remittances: coefficient -1.486** (standard error 0.608).
    - Change in Real GDP Growth in Remitting Countries (one-period lag): coefficient 0.097*** (standard error 0.009).
    - Unemployment Rate in Remitting Countries (one-period lag): coefficient -0.038 (standard error 0.034).
    - Interest rate differential (one-period lag): coefficient 0.025*** (standard error 0.007).
  - Interpretation: remittance growth falls with an appreciating currency, increases with higher GDP growth in remitting countries and with the interest rate differential; Tongans abroad do not fully compensate for exchange rate movements.

### Calibrating Macroeconomic Policies
- Policy priority: Mitigate risks to external and fiscal sustainability and lay foundations for higher growth through improved fiscal management and structural reforms.

#### Fiscal Policy — Background and Key Issues
- FY2009/10 fiscal stance:
  - The deficit is expected to rise to 4 percent of GDP (from 3¼ percent of GDP in the previous fiscal year), reflecting a 10 percent hike in civil servant wages, higher infrastructure spending, and weak revenues (revenues fell short of budget forecasts by about 6 percent of GDP).
  - Authorities introduced an end-of-year cap on spending across line ministries and requested additional budget-support grants from donors; if requested funds are allocated this fiscal year, the estimated fiscal deficit would be around 2½ percent of GDP.
- Public debt:
  - Marked increase in indebtedness primarily reflects two renminbi loans from China’s EXIM bank with a face value totaling over 30 percent of GDP.1
  - This places Tonga in the range of “high risk of debt distress”; government bears all credit and currency risk associated with on-lending of these loans to private parties.
  - Higher debt limits fiscal space and increases vulnerability; further borrowing by the government, even on concessional terms, should be avoided.
- Policy guidance and targets:
  - A steady path of fiscal adjustment is imperative.
  - Staff advised limiting growth in total employee compensation to below the level of CPI inflation, carefully prioritizing current spending, and improving tax administration.
  - Combined with a pickup in activity, continued grant support from donors, and strengthened revenue administration, staff expect to limit the deficit to around 5 percent of GDP in the near term.
  - Over the medium term, a primary surplus target of around 1 percent of GDP should be achievable and would place the fiscal position on a more sustainable path.
  - Continued grant support from donors of the order of 3½ percent of GDP per year will be required; should grants be lower, reductions in associated current and capital spending and reallocation toward higher priority projects will be necessary.
- Revenue administration improvements:
  - Progress made: issuing unique tax identification numbers to corporate taxpayers, introducing self-assessment for personal and corporate income tax, and automating customs processing.
  - Staff recommended increasing resources for tax and customs administration to strengthen auditing and tax collection; authorities emphasized the importance of the new customs management system and arrears collection efforts.

#### Monetary and Exchange Rate Policy (summary of staff advice)
- Near-term stance:
  - Once the recovery in trading partners is firmly established, perhaps by later this year, begin withdrawing monetary stimulus.
  - If inflation risks or downward pressures on reserves materialize, monetary stimulus may need to be withdrawn on a more accelerated timetable.
  - The authorities regarded risks to reserves and likelihood of substantial inflation in coming months as relatively small and vowed to maintain their current monetary stance.
- Operational guidance:
  - Use the full range of monetary policy instruments at the NRBT’s disposal and the flexibility afforded by the existing exchange rate arrangement to contain inflation and maintain an adequate level of international reserves.
  - The authorities indicated they would favor higher reserve requirements and direct limits on credit growth if monetary stimulus needed to be withdrawn.
- Observed developments:
  - The nominal exchange rate has remained broadly stable against the currency basket to which it is pegged, which helped limit post-crisis real appreciation.
  - The real effective exchange rate has appreciated in recent years.

#### Financial Sector Issues
- Banking sector:
  - Banks’ balance sheets have weakened, in large part due to worsening credit quality, which has restrained the availability of credit despite the central bank’s efforts to stimulate demand.
- Supervisory and institutional recommendations:
  - Improve banking supervision.
  - Improve fiscal and debt management, revenue administration.
  - Strengthen the institutional framework for secured lending to enhance access to finance by households and small enterprises.
  - Avoid further government borrowing that increases public debt vulnerability.

#### Structural Improvements to Promote Private Sector-Led Growth
- Structural constraints identified:
  - Geographic isolation, narrow export base, high labor costs, inability to retain skilled labor, and impediments to private sector activity limit growth potential.
- Policy priorities:
  - Continued progress on structural improvements to raise growth potential.
  - Enhance the business environment to promote private sector-led growth and reduce reliance on public spending as a growth driver.

### Key Statistics and Indicators (as reported)
- Growth:
  - 2006/07: -1.2 percent
  - 2007/08: 2.0 percent
  - 2008/09: -0.4 percent
- Inflation:
  - 2006/07: 5.6 percent
  - 2007/08: 12.2 percent
  - 2008/09: 1.2 percent
- Current account (percent of GDP):
  - 2006/07: -8.4
  - 2007/08: -9.0
  - 2008/09: -14.3
- Gross reserves (US$ millions):
  - 2006/07: 47.1
  - 2007/08: 48.2
  - 2008/09: 67.7
- Gross reserves (in months of imports):
  - 2006/07: 3.9
  - 2007/08: 3.2
  - 2008/09: 4.7
- Real effective exchange rate (+ = appreciation):
  - 2006/07: -0.1
  - 2007/08: 2.3
  - 2008/09: 5.5

### Policy Recommendations (condensed)
- Move the near-term fiscal stance toward a more neutral position.
- Establish a comprehensive medium-term fiscal strategy aimed at achieving primary surpluses of around 1 percent of GDP and avoid new borrowing.
- Begin withdrawing monetary stimulus once recovery in trading partners is firmly established; accelerate withdrawal if inflation risks or reserve pressures materialize.
- Use the full range of NRBT monetary instruments and exchange rate flexibility to contain inflation and maintain adequate reserves; consider higher reserve requirements and direct limits on credit growth if necessary.
- Improve fiscal and debt management, revenue administration, and banking supervision.
- Strengthen the institutional framework for secured lending to enhance access to finance by households and small enterprises.
- Continue structural reforms to raise growth potential and rely on donor grants (estimated need of about 3½ percent of GDP per year) while prioritizing spending.

*IMF staff executive summary as presented in the source document.*

### 12.      Fiscal management and medium-term budgeting also need to be strengthened.

### 12.      Fiscal management and medium-term budgeting also need to be strengthened.

### Fiscal management and medium-term budgeting
- Current constraints:
  - Fiscal decision-making is hampered by limited economic and policy analysis and an inadequate budget reporting system.
  - Reporting by line ministries and communication between government agencies need improvement.
- Recommended framework and actions:
  - Adopt a medium-term framework anchored by a path for the fiscal deficit that will achieve sustainable debt levels in the outer years.
  - Integrate the annual budget, spending plans of line ministries, and the medium-term development objectives laid out in the government’s National Strategic Planning Framework (NSPF).
  - Improve fiscal control through more frequent monitoring of expenditure and revenue and better use of the electronic monitoring systems.
- Expected benefits:
  - Better alignment of medium-term fiscal policies with government objectives.
  - Improved prioritization of spending, increased fiscal discipline, and provision of an anchor for expectations.
- Implementation and support:
  - Authorities committed to these reforms over the next two years, supported by technical assistance from the Asian Development Bank (ADB) and Pacific Financial Technical Assistance Centre (PFTAC).

### Debt and on-lending risks
- Staff recommendations:
  - Establish a comprehensive debt management strategy to limit vulnerabilities given increasing credit and currency risks.
  - Exercise care in selecting private sector construction projects that will receive on-lent funds from the government to limit credit risk borne by the public balance sheet.
- Authorities’ response:
  - Recognized risks from a build-up in foreign-currency debt and requested IMF technical assistance to strengthen debt management capacity.

### Monetary policy and exchange rate policies
- Recent monetary easing:
  - National Reserve Bank of Tonga (NRBT) actions since the onset of the global crisis:
    - Lowered reserve requirements from 10 to 5 percent.
    - Reduced the interest rate on its repo facility from 10 to 4½ percent.
    - Suspended issuance of central bank bills.
- Transmission and current stance:
  - Worsening credit quality has reduced banks’ willingness to lend, limiting the effect of looser monetary policy on the real economy.
  - Staff recommended maintaining a neutral monetary policy stance in the months ahead.
  - Significant liquidity exists in the banking system; little reason to further loosen monetary policy.
  - Risk: liquidity overhang could, as banks restore balance sheets, translate into higher credit growth, higher inflation, a worsening current account, and downward pressure on international reserves.
- Conditional tightening tools if pressures materialize:
  - Raise reserve requirements, resume issuance of central bank paper, and raise rates on central bank repo facilities.
  - Authorities indicated a preference for higher reserve requirements and direct limits on credit growth (to avoid burdening NRBT profitability with indirect instruments).
- Reserve and exchange rate posture:
  - Authorities aim to ensure foreign reserves remain at comfortable levels of 3−4 months of imports.
  - The staff assessed the pa’anga as moderately overvalued (see Box III). If balance of payments pressures emerge, NRBT should be ready to gradually depreciate against the basket, supported by further fiscal restraint.
  - Authorities should build an information base to assess potential effects of a depreciation on private balance sheets.
  - NRBT will reassess weights in the currency basket to reflect economic circumstances, shifting trade patterns, and increased renminbi exposure; PFTAC to provide technical assistance.

### National Strategic Planning Framework (NSPF) — key features and implementation
- Time horizon and purpose:
  - Takes a longer-term strategic approach to achieving sustainable development (5–10 years).
  - Focuses on a limited number of government priorities; implementation details to be laid out in corporate plans of government agencies.
- Seven outcomes considered fundamental to sustained and more equitable economic growth in Tonga:
  - (i) community development that meets service needs;
  - (ii) private sector growth (through better engagement with the government, appropriate incentives and streamlining of rules and regulations);
  - (iii) constitutional reform;
  - (iv) improved provision and maintenance of infrastructure;
  - (v) increased performance of technical and vocational education and training to meet the challenges of maintaining and developing services and infrastructure;
  - (vi) improved people health by minimizing the impact of non-communicable diseases; and
  - (vii) environmental sustainability and climate change integrated into all program planning and execution.
- Implementation and monitoring:
  - NSPF is being refined to include performance targets and indicators and will be implemented through government agencies’ corporate plans, which will be linked to the budget.
  - NSPF requires a robust management and monitoring mechanism to track achievement of strategic objectives and focuses on the quality of government agencies’ corporate plans.
  - Preparation of government agencies’ corporate plans is underway with support from AusAID, ADB, and PFTAC, especially on strengthening the link between the NSPF, the annual budget process, and the medium-term budget framework.

### Financial sector issues and prudential policy
- Banking sector developments:
  - Following deterioration in banks’ balance sheets in 2008, provisioning has increased.
  - Banks are improving risk management practices, including greater staff training on credit risk analysis, better communication with management, and more frequent audits.
  - Most credit-related losses have been frontloaded; banks expected to return to profitability by the second half of the year.
- Prudential supervision recommendations:
  - Further step up prudential regulations and supervision to promote financial stability and improve intermediation.
  - Progress noted: setting trigger levels for capital, liquidity, and asset quality requirements; requiring improved disclosure to customers about the full costs of new loans (including all fees, interest, and charges).
  - Staff encouraged NRBT to increase the frequency of on-site visits and improve banks’ prudential reporting requirements.
- Interest rate administration:
  - Some political pressure exists to administer deposit and lending rates.
  - Staff advised maintaining market-determined rate setting; administering rates likely to cause significant credit rationing and impede banks’ risk pricing.

### Legal and structural reforms to improve access to credit
- Collateral and credit information constraints:
  - Lack of collateral and difficulties in attaching collateral are significant impediments to business lending.
  - Banks rely on informal information and past relationships due to limited borrower credit information.
  - Property registry systems are costly and time consuming; Tonga’s registry is better than several island nations but remains cumbersome.
- Recommended reforms:
  - Improve legal framework for collateralized borrowing to lower intermediation costs, protect bank balance sheets, and restart bank lending.
  - Consider instituting a centralized credit bureau and strengthening creditor rights to ensure timely registering and recovery of collateral.
  - Enact planned secured property and bankruptcy protection laws to expand access to finance.
  - Improve transparency and disclosure for financial services to afford greater protections to bank borrowers.
- Government measures tied to NSPF:
  - Rationalize public enterprises, modernize the commercial legal framework, and provide better access to finance.
  - Proposal to lengthen land leases to over 99 years to encourage private construction and investment and increase availability of collateral.

### Structural improvements to promote private sector-led growth
- Progress and remaining challenges:
  - NSPF holds promise for longer-term private sector-led development.
  - Additional efforts needed to reduce the cost of doing business and improve the business environment.
- Specific recommendations to improve the business environment:
  - Increase access to land for development.
  - Reduce the number of licenses needed for private sector projects and speed up their approval.
  - More narrowly define areas where foreign investment is not permitted.
  - Improve efficiency in delivery and generation of utilities given utility costs are among the highest in the Pacific.

*IMF staff report excerpt: _cr10112 - 12.      Fiscal management and medium-term budgeting also need to be strengthened.*

### 23.      Activity is expected to rebound next year. Growth should reach 1¾ percent in

### 23.      Activity is expected to rebound next year. Growth should reach 1¾ percent in

### Near-term outlook and inflation
- Growth should reach 1¾ percent in FY2010/11, boosted by increased construction activity.
- Tourism and remittances should begin to pick up, albeit slowly, as the global recovery takes hold.
- With the recapitalization of banks and most losses now realized, lending could resume.
- Inflation should rise in the coming months as a result of the expected recovery in domestic demand and a recent increase in electricity prices but should end the year at around 4 percent.

### Medium-term growth constraints
- Prospects are constrained by:
  - Tonga’s geographic isolation.
  - Its narrow export base.
  - The high cost of labor and an inability to retain skilled labor.
  - Impediments to private sector activity.
- Government policies will need to focus on mitigating these limitations.

### Balance of risks
- The balance of risks is tilted to the downside.
- Near-term risks include an uncertain strength of the global recovery, with multiple risks in Europe and the United States.
- A further rise in world commodity and food prices would hit Tonga hard, affecting inflation, growth, and the current account deficit.
- Tonga’s high public debt poses a considerable risk to economic prospects through its potential impact on external sustainability and shock response.

### Debt vulnerabilities and external position
- The increase in both Tonga’s external and public debt over the past year has left the economy more vulnerable to shocks.
- The level of Tonga’s debt puts the country into the range of “high risk of debt distress” according to the World Bank-IMF debt sustainability framework.
- There is considerable credit and currency risk associated with some of Tonga’s debt.
- Mitigating these vulnerabilities will require:
  - Continued progress on structural improvements to raise growth potential.
  - Continued support from donors.
  - Fiscal consolidation.
  - Careful management of liabilities, reserves, and Tonga’s external position.

### Fiscal policy near-term guidance
- There is little scope for further fiscal stimulus in the coming fiscal year.
- The government should:
  - Limit growth in employee costs to at most the level of CPI inflation.
  - Carefully prioritize current spending.
  - Further improve tax administration.
- Economic activity could be supported by bringing forward some donor-financed infrastructure spending, subject to capacity constraints.

### Fiscal strategy to put debt on a downward path
- In the coming years a sustained effort is needed to put public debt firmly on a downward path.
- The government should aim at a primary surplus target of around 1 percent of GDP to lower the debt and place the fiscal position on a more sustainable path.
- Achieving this adjustment will require progress on multiple fronts over the medium term, including:
  - Stepping up revenue administration and expenditure control.
  - Prioritizing expenditure.
  - Limiting loan drawdown to finance projects that are productive.
  - Structural reforms.
- Establish a comprehensive debt management strategy that aims at limiting large credit and currency risks in the government balance sheet.
- Fiscal efforts need to be supplemented by continued provision of grants from donors; lower-than-expected grants would affect project spending plans and require further fiscal restraint and possible redirection toward higher priority projects.

### Monetary policy stance and risks
- Monetary policy should maintain a neutral stance in the months ahead.
- The loosening of monetary policy in FY2009/10 was appropriate but failed to fully translate into looser monetary conditions as banks maintained a tight lending stance to restore balance sheet health.
- There is now ample liquidity in the banking system and little need for further loosening.
- Risk: normalization could allow the past expansionary stance to feed through to higher inflation and downward pressure on international reserves.

### Triggers and tools for monetary tightening
- If higher inflation than expected in the baseline, or downward pressures on reserves, materialize, monetary policy should be tightened.
- The NRBT should use the wide range of tools at its disposal, including:
  - Raising reserve requirements.
  - Resuming the issuance of central bank paper.
  - Raising interest rates on its repo facility.
- The use of direct credit controls should be limited to minimize associated distortions.
- Such tightening could begin once the recovery in Tonga’s main trading partners is firmly established, since that recovery typically leads to stronger remittances and imports and exerts downward pressure on the reserve coverage ratio.

### Exchange rate flexibility and external stability
- Making use of the flexibility afforded by the current exchange rate arrangement is critical for safeguarding external stability.
- Staff assesses the currency to be moderately overvalued.
- Little scope exists to tighten monetary conditions through a nominal appreciation; the NRBT should stand ready to gradually depreciate against the basket to safeguard external stability.
- Effective depreciation would need to be accompanied by further fiscal restraint given the effect a weaker currency would have on the public debt burden.
- NRBT’s decision to review the current weights in the basket is welcome.

### Financial sector supervision and intermediation
- Further stepping up prudential regulations and supervision will promote financial stability and improve intermediation.
- NRBT has steadily strengthened bank supervision and recently required banks to improve disclosure to customers about full costs of new loans (including all fees, interest, and charges).
- NRBT needs to continue improving supervision and monitoring of banks, including more on-site visits and strengthening prudential reporting requirements.

### Legal and institutional reforms to lower borrowing costs
- Improving the legal framework for collateralized borrowing can lower financial intermediation costs and restart bank lending.
- Significant scope exists to improve the institutional framework for lending to increase access to finance and lower the cost of borrowing.
- Further improvements to transparency and disclosure for financial services will afford greater protections to bank borrowers and lower credit spreads.
- Administering interest rates should be resisted as it would likely result in significant credit rationing and hamper banks’ ability to price risk.

### Policies to promote private-sector-driven growth
- Additional efforts are needed to promote private drivers of growth, including:
  - Improve the institutional framework for lending—including the enforcement of creditor rights to collateral—to increase access to finance and lower the cost of borrowing.
  - Extend land leases to over 99 years to encourage construction and investment.
  - Reduce the number of business licenses.
  - Lower barriers to foreign investment.

*IMF staff report content as provided.*

### 35.      It is recommended that the next Article IV consultation take place on a standard

### _cr10112 - 35.      It is recommended that the next Article IV consultation take place on a standard

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

### Key macroeconomic indicators (levels and growth)
- Nominal GDP (2008/09): US$ 328.4 million
- Population (2006): 101,991
- GDP per capita (2008/09): US$ 3,220
- Quota: SDR 6.9 million
- Real GDP growth (2005/06–2010/11, annual percent change): 2/0.5-1.22.0-0.4-0.51.7
- Consumer prices (period average, 2005/06–2010/11): 7.05.19.85.02.24.2
- Consumer prices (end of period, 2005/06–2010/11): 6.45.612.21.24.34.1

### Government finance (summary measures and ratios)
- Total revenue and grants (2005/06–2010/11, percent of GDP): 26.628.326.324.025.329.2
  - Total revenue: 24.924.624.917.418.718.8
  - Grants: 1.73.71.36.66.610.4
- Total expenditure and net lending: 29.427.324.727.329.234.3
  - Current expenditure: 28.826.224.324.123.922.8
  - Capital expenditure: 0.80.90.42.32.78.6
- Overall balance (percent of GDP): -2.81.11.5-3.3-3.9-5.1
- Overall balance (excl. China's EXIM bank loans): .........-3.3-2.4-2.5
- External financing (net): 0.40.10.2-0.73.65.4
- Domestic financing (net): 2.4-1.2-1.78.60.5-0.3
- Privatization receipts: 0.00.00.0-4.6-0.20.0

- Fiscal-year table highlights (2008/09–2010/11, in millions of pa'anga and percent of GDP):
  - Total revenue and grants (2008/09–2010/11, millions): 154.5171.1171.2164.4178.2217.8
  - Total expenditure and net lending (2008/09–2010/11, millions): 170.7164.7161.4187.2205.9256.0
  - Overall balance (incl. grants) (2008/09–2010/11, millions): -16.16.49.8-22.8-27.8-38.1
  - Total financing (2008/09–2010/11, millions): 16.1-6.4-9.822.827.838.1

### Money, credit, and banking
- Total liquidity (annual percent change, 2005/06–2010/11): 13.313.36.7-1.14.31.4
  - Broad money (M2): 16.611.98.2-1.82.02.5
  - Domestic credit: 25.811.611.6-4.2-11.21.3
    - Private sector credit: 22.69.518.0-2.9-11.02.0
- Net foreign assets (in millions of pa'anga, end of period): 73.281.980.5117.6123.3136.2
  - Foreign assets: 97.0104.9101.5155.5171.1189.0
    - NRBT: 85.292.990.7137.7157.4175.3
    - DMBs: 11.812.010.817.813.713.7
  - Foreign liabilities: -23.7-23.0-21.0-37.9-47.8-52.8
- Total liquidity (in millions of pa'anga, end of period): 253.4287.1306.3302.8315.9320.2
  - Broad money (M2): 237.5265.8287.5282.3287.9295.1
    - Narrow money: 55.773.872.677.9106.095.0
    - Quasi money: 181.8192.0214.9204.4181.9200.1

### Balance of payments and external sector
- Exports, f.o.b. (2005/06–2010/11, millions of U.S. dollars): 15.413.312.45.55.26.3
- Imports, f.o.b. (2005/06–2010/11, millions): -122.2-108.6-138.1-130.1-115.7-131.5
- Services (net): -7.8-17.9-3.3-2.6-3.3-5.0
- Investment income (net): 2.83.53.44.63.23.1
- Current transfers (net): 88.984.294.775.859.166.7
  - Private transfer receipts: 102.093.3106.784.063.070.7
- Current account balance (millions of U.S. dollars): -22.8-25.5-30.9-46.9-51.5-60.5
  - Current account balance (excl. China's EXIM bank loans): -22.8-25.5-30.9-46.8-42.6-45.0
  - (In percent of GDP): -7.9-8.4-9.0-14.3-17.4-19.9
- Overall balance (change in gross official foreign reserves): 0.64.2-1.422.62.91.3
- Gross official foreign reserves (in millions of U.S. dollars): 40.447.148.267.770.672.0
  - In months of goods and services imports: 3.13.93.24.75.34.8
- External debt (in percent of GDP): 29.027.125.331.544.250.7
- Debt service ratio: 1.11.11.41.21.11.5
- Exchange rates:
  - Pa'anga per U.S. dollar (period average): 2.02.01.92.1......
  - Pa'anga per U.S. dollar (end of period): 2.11.91.82.0......

### Balance of payments summary (2005/06–2010/11 highlights)
- Trade balance: -106.7-95.3-125.7-124.6-110.5-125.2
- Capital and financial account balance: 22.526.936.355.654.461.8
  - Official capital flows (net): 8.49.811.917.734.742.1
    - Of which: China's EXIM bank loans (noted in projections): .........20.133.519.3
  - Private capital flows (net): 14.117.124.437.919.719.7
- Errors and omissions: 1.02.7-6.713.90.00.0
- Overall balance (change in gross official reserves): 0.64.2-1.422.62.91.3

### Medium-term scenario (2007/08–2014/15, selected projections)
- Real GDP (annual percent change): 2.0-0.4-0.51.71.71.81.81.8
- Consumer prices (end of period, annual percent): 12.21.24.34.14.16.06.06.0
- Total revenue and grants (percent of GDP): 26.324.025.329.227.226.225.724.3
  - Total expenditure and net lending (percent of GDP): 24.727.329.234.332.031.428.625.6
- Overall balance (percent of GDP): 1.5-3.3-3.9-5.1-4.7-5.2-2.8-1.3
- Current account balance (millions of U.S. dollars): -30.9-46.9-51.5-60.5-63.3-59.6-56.2-49.2
  - (In percent of GDP): -9.0-14.3-17.4-19.9-20.2-18.1-16.2-13.5
- Gross international reserves (end of period, millions of U.S. dollars): 48.267.770.672.069.967.365.255.6
  - In months of imports (goods and services): 3.24.75.34.84.54.23.83.2
- Public sector external debt (percent of GDP): 25.331.544.250.752.751.148.545.5

### Social and structural indicators (select Millennium Development Goals indicators)
- Literacy rate, youth female (% of females ages 15-24): 99..100100
- Literacy rate, youth male (% of males ages 15-24): 99..100100
- Primary completion rate, total (% of relevant age group): 133114104137100
- Immunization, measles (% of children ages 12-23 months): 8694959999
- Mortality rate, infant (per 1,000 live births): 2624222019
- Life expectancy at birth, total (years): 7070717272
- Mobile cellular subscriptions (per 100 people): 0002949
- Internet users (per 100 people): 0.00.12.42.98.1
- GNI per capita, Atlas method (current US$): 1,1601,7401,6501,9502,560

### Fund relations and institutional notes (as of March 31, 2010)
- Membership Status: Joined September 13, 1985; Article VIII.
- Quota: 6.90 SDR Million (100.00 percent of quota)
  - Total holdings of currency: 5.19 (75.20 percent of quota)
  - Reserve position in Fund: 1.71 (24.81 percent of quota)
- SDR Department:
  - Net cumulative allocation: 6.58 (100 percent)
  - Holdings: 7.07 (107.48 percent)
- Outstanding Purchases and Loans: None.
- Financial Arrangements: None.
- Projected Obligations to Fund (SDR Million; forthcoming 2010–2014): 0.000.000.000.000.00 (Principal and Charges/Interest; Total 0.000.000.000.000.00)
- Exchange Rate Arrangement summary:
  - Since February 11, 1991, the pa’anga value is determined based on a weighted basket of currencies comprising the United States, Australian, and New Zealand dollars, with the U.S. dollar as the intervention currency.
  - In July 2000, the Japanese yen was added to the basket, and the monthly maximum adjustment limit was raised to 5 percent from 2 percent.
  - Authorities removed in April 2010 the exchange restriction in the form of a tax certification requirement applied to various current international transactions (listed in the annex text).
- Last Article IV Consultation: Staff discussions were held during May, 2009 and the Executive Board discussed the staff report (IMF Country Report No. 09/292) on September 4, 2009.
- Technical Assistance: LEG assistance on AML/CFT issues; PFTAC assistance on budgetary management; tax administration; banking legislation and supervision; and balance of payments and national accounts statistics.
- Resident Representative: None.

*Source: Staff Report for the 2010 Article IV Consultation—Informational Annex (April 21, 2010).*

### ANNEX II. TONGA: RELATIONS WITH THE

### ANNEX II. TONGA: RELATIONS WITH THE PACIFIC FINANCIAL TECHNICAL ASSISTANCE CENTRE (PFTAC)

### Assistance overview
- Timeframe and scale:
  - Assistance to Tonga since 2006 included 27 advisory missions across all technical assistance (TA) sectors.
  - During 2006–March 2010, Tonga has sent 63 officials to the Centre’s regional seminars, workshops and training courses.
  - Six attachments were organized.
  - Scoping mission on Medium Term Budgeting in Tonga scheduled for late March 2010.
- PFTAC mandate and membership (as described):
  - The Pacific Financial Technical Assistance Centre (PFTAC) in Suva, Fiji is a regional technical assistance institution operated by the IMF with financial support of the Asian Development Bank, Australia, Japan, Korea and New Zealand.
  - Member countries are: Cook Islands, Federated States of Micronesia, Fiji, Kiribati, Marshall Islands, Nauru, Niue, Palau, Papua New Guinea, Samoa, Solomon Islands, Tokelau, Tonga, Tuvalu, and Vanuatu.

### Public Financial Management
- Focus and activities since 2003:
  - Missions focused on complementing assistance by other TA agencies, including introduction of a midyear economic review and fiscal update, reconciliation of monetary and fiscal data, and changes in budget documentation.
  - For the 2003/04 and 2004/05 budgets, assistance was provided in presenting the final aggregate budget figures on a GFSM 2001 basis.
  - In 2004, arranged for a Tongan official to participate on a delegation of Pacific Island officials to the Australian Commonwealth Ministry of Finance.
  - 2005: PFTAC PFM Advisor participated in a joint donor/government Feasibility Study related to a proposed long-term Financial and Economic Management Program (FEMP) and worked with the Ministry of Finance on assessing financial implications of the proposed civil service wage increase.
  - Peripatetic advisor assistance provided in 2006 and again in 2007 to assist in revenue estimation work.
  - PFM Advisor delivered lectures on PFM to all CEOs in late April 2007.
  - Joint PFTAC mission on revenue estimation visited Tonga in mid-March 2008.
  - PFTAC mission on decentralization visited Tonga in May 2008 and made several recommendations.
  - A scoping mission on Medium Term Budgeting scheduled for late March 2010.

### Tax Administration and Policy
- Reforms and outcomes:
  - Tonga has improved revenue policy and administration over the last three years.
  - Key outcomes include:
    - Passing of new Income tax and Customs Acts, both self assessed.
    - A post implementation review of the value-added tax (VAT).
    - Substantial change to tax administration principally with the introduction of self assessment.
  - Progress complemented the introduction of the consumption tax in 2005 and has seen tax revenues increase steadily to GDP in recent years.
- IMF/PFTAC mission March 2008:
  - Objective: review tax policy issues in small Pacific island countries, consider fiscal challenges posed by prospective trade liberalization, and assess experience with VAT.
  - Mission visited Fiji, Kiribati, Samoa, Solomon Islands, and Tonga.
  - In Tonga, mission found the consumption tax was catalytic to improvement of revenues in an environment of political will to reform and dissatisfaction with performance of some existing taxes.
- Trade liberalization revenue risk:
  - Revenue losses arising from trade liberalization through the Pacific Island Countries Trade Agreement (PICTA) and Pacific Agreement for Closer Economic Relations (PACER) have been estimated as high as 27 percent of total revenue by external research.
  - This presents an immediate issue for Tonga to replace those lost revenues.
- Other engagements:
  - Informal discussions between PFTAC and Tongan revenue officials regarding modernizing of stamp duties and Customs administration and processes to improve trade revenues.

### Banking Sector Regulation and Supervision
- Assessments and legislative changes:
  - An assessment to determine compliance with the Basel Core Principles for Effective Banking Supervision (BCP) was conducted in 2002; it identified shortcomings in Tonga’s legal framework and resulted in a review of the Financial Institutions Act (FIA).
  - The enhanced FIA was enacted in late 2004.
  - A TA mission assisted with drafting regulations and guidelines and establishing implementation procedures in April 2005.
- Supervisory capacity building:
  - Further assistance in conducting on-site examinations of banks provided in late 2005 and again in February 2006.
  - Amendments to the NRBT Act, which will strengthen the central bank’s enforcement capacity, are still awaiting Parliament’s enactment.
  - PFTAC arranged, through funding provided in late 2005 by NZAID, for renewal of the secondment of a central banking manager from the Reserve Bank of Fiji to serve as the Deputy Governor of the National Reserve Bank of Tonga.
  - Peripatetic advisors to provide assistance and training in the conduct of on-site bank examinations are being provided by Monetary and Capital Markets Department (MCM).
- Recent and planned work:
  - The PFTAC Advisor visited the NRBT in January 2010 to review the adequacy of prudential reporting requirements for banks.
  - Based on that visit, additional visits by the Advisor are planned for later in 2010 to strengthen prudential bank reporting requirements and assist authorities in revising/updating bank regulations.

### Economic and Financial Statistics
- Reviews and GDDS engagement:
  - In 2002, two reviews were undertaken in accordance with the GDDS and the Data Quality Assessment Framework: one on BOP statistics and the other on the wider statistical system.
  - Subsequent missions in 2004 finalized GDDS metadata, provided training in BOP concepts and practices, developed a new BOP business survey, and reviewed national accounts data.
  - September 2005: partial update of the 2002 statistical system review focused on outputs of the Statistics Division of the Ministry of Finance.
  - GDDS metadata was approved and published in 2006 on the Data Dissemination Bulletin Board.
- Balance of Payments and National Accounts improvements:
  - A TA mission in April 2007 provided further assistance with reviewing BOP statistics.
  - Follow-up missions on BOP statistics were undertaken in April 2008 and March 2009, resulting in revised BOP estimates based on the Balance of Payments Manual, 5th edition (BPM5) standards being compiled.
  - A further advisory mission on BOP was undertaken in March 2010 to assist in improving use of source data and methodology, and mapping estimates to the BPM6 classification.
  - Advisory mission on revenue estimation and review of National Accounts Statistics (NAS) in mid-March 2008; further TA advisory mission in March 2009 and a short-term expert mission in February 2010 implemented significant improvements in NAS methodology and use of source data, resulting in substantial improvements in the estimates and dissemination of an expanded range of NAS estimates.
  - TA expert missions to develop producer price indexes were undertaken in July 2008 and March 2009.

*Source: ANNEX II. TONGA: RELATIONS WITH THE PACIFIC FINANCIAL TECHNICAL ASSISTANCE CENTRE (PFTAC) (As of March 2010).*

### Annex V. Tonga: Statistical Issues

### Annex V. Tonga: Statistical Issues

### Real Sector Statistics
- Assessment: Economic statistics are broadly adequate for surveillance, but data deficiencies complicate monitoring and policy formulation. The Statistics Department (SD) and the Ministry of Finance (MOF) have received regular technical assistance in national accounts, government finance, and balance of payments (BOP) statistics from STA and PFTAC; nevertheless, data provision to the Fund continues with long delays.
- Main data sources: Quarterly Bulletin of the National Reserve Bank of Tonga (NRBT); annual and semi-annual budget reports from the MOF.
- GDDS participation: Participating since May 30, 2006; metadata posted on the Fund’s DSBB.
- National accounts:
  - New series released June 2009 following PFTAC assistance in 2008 and 2009.
  - Retains 2000/01 base year but revised to improve coverage and estimation techniques.
  - Source data remain weak and need improvement to allow a rebase of the national accounts.
- Price indices:
  - Consumer Price Index is based on a basket from the 2000/01 Household Income and Expenditure Survey.
  - Technical assistance in 2008 on development of an import price index.
- Labor statistics: Weak — employment statistics have not been compiled since 2003; average earnings statistics are not available.

### Government Finance Statistics
- FY 2002/03 Budget Statement introduced presentation of fiscal data compiled according to the 2001 Government Finance Statistics Manual methodology.
- Remaining weaknesses:
  - Need for proper classification of transactions to permit reconciliation with monetary financing data.
  - Lags in updating the accounting system should be shortened.
  - Published data are often subject to significant revisions.
  - No data are reported for publication in the IFS or GFS Yearbook.

### External Sector Statistics
- BOP compilation:
  - Official BOP statistics compiled annually by the SD with long lags.
  - Monthly trade figures from customs available with a three-month lag.
  - NRBT unofficially compiles monthly BOP statistics from Overseas Exchange Transactions records with a six-week lag.
  - Significant differences exist between BOP estimates compiled by SD and NRBT; large errors and omissions suggest possible under recording of imports.
- PFTAC assistance:
  - March 2009: SD developed revised draft BoP statistics and methodology and made recommendations for improvements.
  - Follow-up mission in March 2010.
- MOF system: Provides detailed information on official sector external disbursements and debt service.

### Monetary and Financial Statistics
- NRBT reporting:
  - Reports data for the central bank, other depository corporations, and monetary aggregates using the standardized report forms (SRFs).
  - These data were published for the first time in the March 2008 issue of IFS and IFS Supplement on Monetary and Financial Statistics.
- Needed actions: NRBT must allocate resources to improve the quality of MFS by obtaining source data suitable for compilation of the SRFs in line with the Monetary and Financial Statistics Manual recommendations.

### Tonga: Table of Common Indicators Required for Surveillance (As of April 7, 2010)
- Selected entries (date of latest observation / date received / frequency of data / reporting / publication):
  - Exchange Rates: 2/2010 / March/2010 / M / M / M
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: 1/2010 / March/2010 / M / M / M
  - Reserve/Base Money: 1/2010 / March/2010 / M / M / M
  - Broad Money: 1/2010 / March/2010 / M / M / M
  - Central Bank Balance Sheet: 1/2010 / March/2010 / M / M / M
  - Consolidated Balance Sheet of the Banking System: 1/2010 / March/2010 / M / M / M
  - Interest Rates: 1/2010 / March/2010 / M / M / M
  - Consumer Price Index: 1/2010 / March/2010 / M / M / M
  - Revenue, Expenditure, Balance and Composition of Financing – Central Government: 02/2010 / March/2010 / M / Q / Q
  - Stocks of Central Government and Central Government-Guaranteed Debt: 02/2010 / March/2010 / A / A / A
  - External Current Account Balance: Q4/2009 / March/2010 / Q / Q / Q
  - Exports and Imports of Goods and Services: Q4/2009 / March/2010 / Q / Q / Q
  - GDP/GNP: 2008/09 / March/2010 / A / A / A
  - Gross External Debt: 6/2009 / March/2010 / A / A / A
  - International Investment Position: NA / NA / NA / NA / NA

### Debt Sustainability Analysis — Summary Findings and Assumptions
- Overall judgment: Based on the joint IMF-WB LIC DSA, Tonga remains at a high risk of debt distress.
- Key drivers of higher near-term debt:
  - Recently contracted Y291 million ($42½ million) China EXIM bank loan for road construction.
  - Two China Exim Bank reconstruction loans with face values totaling over 30 percent of GDP.
  - Weaker external environment impacting GDP and the fiscal balance.
- Remittances cushion:
  - Remittances are over 30 percent of GDP and are the largest source of foreign exchange earnings.
  - One-half of Tongans live abroad (mostly in Australia, New Zealand, and United States).
  - Remittances have averaged more than twice export receipts over the past decade.
  - Coefficient of variation: remittances 1.3; export receipts 2.
- Public sector debt dynamics:
  - Total public sector debt stock (including publicly guaranteed debt) rose substantially in FY2008/09 and FY2009/10, reaching over 50 percent of GDP.
  - Despite rise in overall debt, domestic debt has fallen from around 20 percent of GDP at the beginning of the decade to around a projected 7¼ percent of GDP by June 2010.
  - Government issued bonds amounting to net issuance of T$8 million in the fiscal year, leaving outstanding bonds at an expected 4¼ percent of GDP by end-June.
  - Remaining domestic debt mainly reflects government guarantees and obligations to the Retirement Fund Board.
- Assumed fiscal strategy going forward (DSA baseline):
  - Primary surpluses of around 1 percent of GDP rather than 0.4 percent assumed last year.
  - New concessional external borrowing to finance capital construction of only 4 million a year over 2015/16–2029/30, rather than over 9 million assumed last year.
- Projected external debt profile (baseline):
  - PPG external debt is currently over 30 percent of GDP.
  - PV of PPG external debt projected to increase to about 42 percent of GDP by 2011/12 (12 percentage points above the threshold), before dropping under the threshold by 2017/18 and declining to around 8 percent of GDP by 2030.
  - External current account deficit projected to reach 20 percent of GDP in 2011/12, up from 14 percent of GDP in 2008/09; over the medium term, the deficit should return to around 10½ percent of GDP.
  - Net FDI projected to stabilize at around 9 percent of GDP.
- Debt burden relative to exports and remittances:
  - PV of PPG external debt-to-exports ratio is well over two-and-a-half times the indicative threshold of 100 percent and projected to remain above the threshold well past 2020.
  - When remittances are included, the PV of PPG debt is projected to exceed 100 percent in 2010‒12 and remain above the modified threshold until around 2013/14 (10 years sooner than when remittances are ignored).
  - PV of debt is expected to decline below the revenue threshold by 2014.
- Historical and projected macro assumptions (excerpted from DSA and Box 1):
  - Real GDP growth (percent): historical and projections summarized in the DSA and assumed to average around 1½ percent over 2009/10–2014/15.
  - Growth of exports of goods and services (U.S. dollar terms): projections included in the DSA.
  - Growth of remittance inflows (U.S. dollar terms): projections included in the DSA.
  - Non-interest current account balance (in percent of GDP): projected changes noted in the DSA.
  - GDP deflator growth (U.S. dollar terms): projections noted in the DSA.
  - Primary deficit (in percent of GDP): DSA assumes improvement to allow primary surpluses of around 1 percent of GDP over the medium term.
- Box 1 — Key Assumptions (highlights):
  - Real GDP growth projected to average around 1½ percent over 2009/10–2014/15.
  - Current balance assumed to narrow from a deficit over 5 percent of GDP in 2009/10 to a surplus of ½ percent by 2014/15.
  - Over the longer-term, an average current balance of around ¾ percent of GDP and a primary fiscal balance of around 1 percent of GDP.
  - Grants projected to decline but remain significant at around 2½ percent of GDP over the longer term.
  - Following last disbursement of current China Exim Bank loan (in 2012/13), all future external borrowing assumed from concessional IFI facilities.
  - Export base projected to remain narrow and relatively undiversified; remittances expected to recover as major source countries rebound.

### Vulnerabilities and Policy Implications (from DSA)
- Vulnerabilities:
  - High and rising public sector debt in the short term (over 50 percent of GDP).
  - External debt indicators breach policy-dependent thresholds in 2009/10 before receding.
  - Narrow export base and reliance on remittances and donor support.
- Policy recommendations and priorities:
  - Sound macroeconomic policies to improve Tonga’s growth potential on a sustained basis.
  - Export diversification.
  - Continued efforts in fiscal consolidation to limit additional borrowing and preserve resources for social and developmental priorities as outlined in the National Strategic Planning Framework.

*Source: Annex V. Tonga: Statistical Issues; Joint IMF/World Bank Debt Sustainability Analysis 2010 (April 21, 2010).*

### 7.      Debt and debt service are expected to stay above the exports threshold for most

### _cr10112 - 7.      Debt and debt service are expected to stay above the exports threshold for most

### Key findings on external debt, debt service, exports, and remittances
- Debt and debt service are expected to stay above the exports threshold for most of the projection period, but not when remittances are accounted for.
- The global economic crisis will make it harder for Tonga to expand its very narrow export base in the short term, aggravating solvency and liquidity risks.
- Remittances will decline in the short term, but they are expected to recover and stabilize at around 30 percent of GDP over the longer term, somewhat below historical highs.
- Relative to exports and remittances, external debt service remains well under 10 percent throughout the projection period to 2029/30.
- The ratio of debt service to revenue remains well below the threshold of 25 percent throughout the projection period, albeit with a deterioration in the short to medium term.

### Alternative scenario and stress tests — external DSA
- Export shock stress test:
  - The present value of debt exceeds 500 percent of exports and remains more than 10 percent above the 100 percent threshold for the entire projection period.
  - Debt service to exports ratios rise above the 15 percent threshold, reaching over 30 percent in 2015.
- Large one-time depreciation:
  - The present value of debt rises to around 60 percent of GDP and remains persistently above the 30 percent threshold even after 2020.
  - The present value of debt-to-revenue ratio persistently breaches its threshold.
- Several other potential shocks would see debt levels remain above the indicative GDP and export thresholds for a prolonged period.
- Similar stress outcomes emerge when remittances are considered.
- The historical scenario is more sanguine mainly because the current rise in construction projects and donor assistance result in a larger current account deficit than occurred historically; if the current account deficit were at historical levels, debt could be reduced more quickly.

### Public sector DSA — baseline
- The public sector DSA reinforces the conclusions of the external DSA.
- Resumption of large scale public sector borrowing for road building and reconstruction of the capital reversed the prior trend.
- Present value of public debt builds up to almost 50 percent of GDP in 2011/12 before declining steadily thereafter under the baseline scenario.
- This highlights the importance of fiscal prudence and a continued commitment to limit new public borrowing.

### Public sector DSA — alternative scenarios and stress tests
- Stress tests show vulnerabilities throughout the projection period, especially to a sizable depreciation.
- A 30 percent depreciation results in the largest rise in the overall public debt burden:
  - The NPV of public debt would rise and remain above 60 percent of GDP until 2013/14.
  - The NPV would be at 30 percent of GDP in 2030.
- Maintaining the primary balance at its historical level (around balance) brings debt down faster given the large deficits implied by the Exim bank financed construction currently in train.
- The construction burst will require larger longer-term primary surpluses (of around 1 percent of GDP) to ensure debt in line with the baseline.

### Staff assessment
- Tonga remains at a high risk of external debt distress.
- Very high and stable remittance inflows clearly mitigate liquidity risks, but remittances are insufficient to limit risks from projected debt service payments.
- Tonga is able to service its current obligations.
- Overall public sector debt dynamics, while elevated over the short term, show a downward trend over the longer run, suggesting debt dynamics are manageable despite being at high risk.

*Source: IMF staff report excerpt.*

### 12.      Key medium-term vulnerabilities include lower GDP growth, major external

### 12.      Key medium-term vulnerabilities include lower GDP growth, major external shocks, and borrowing on less concessional terms.

### Major vulnerabilities and policy priorities
- Key vulnerabilities: lower GDP growth, major external shocks, and borrowing on less concessional terms.
- Policies underscored as important:
  - Sound macroeconomic policies to improve Tonga’s growth potential on a sustained basis.
  - Export diversification.
  - Continued efforts in fiscal consolidation.
  - Increased utilization of donor grants and limiting recourse to further borrowing (even on concessional terms) to maintain manageable public debt dynamics and reduce the risk of external debt distress.
  - Sound public debt management anchored in a medium-term debt management strategy and in line with the medium-term fiscal framework.
  - Priority for projects that would help generate high growth and employment, especially in the context of the NSPF, to help ensure debt service capacity in the future.

### Debt dynamics and projections (selected figures)
- External debt (nominal) series (in percent of GDP): 27.1; 25.3; 31; 44.2; 50.7; 52.8; 51.2; 47.9; 44.8; 29.4; 11.6.
- Change in external debt: -1.9; -1.8; 6.2; 12.7; 6.5; 2.1; -1.6; -3.2; -3.2; -2.8; -1.0.
- Identified net debt-creating flows: 1.6; -1.4; 3.9; 10.8; 12.5; 12.6; 10.0; 7.8; 4.9; 0.7; 1.9.
- Non-interest current account deficit (in percent of GDP): 8.2; 8.7; 13.8; 4.7; 5.7; 16.5; 19.0; 19.1; 17.1; 15.2; 12.6; 10.1; 11.3; 10.4.
- Deficit in balance of goods and services (in percent of GDP): 37.5; 37.6; 38.7; 38.3; 42.7; 43.3; 43.3; 43.2; 42.2; 41.2; 41.9.
- Exports (in percent of GDP): 10.8; 14.4; 13.9; 15.5; 15.9; 16.0; 15.9; 15.8; 15.7; 16.1; 16.1.
- Imports (in percent of GDP): 48.4; 51.9; 52.6; 53.8; 58.6; 59.3; 59.2; 59.0; 58.0; 57.3; 58.1.
- Net current transfers (negative = inflow, percent of GDP): -27.9; -27.6; -23.1; -28.3; 4.7; -19.9; -21.9; -22.2; -24.2; -26.0; -27.7; -29.6; -29.6; -29.6.
- Net FDI (negative = inflow, percent of GDP): -5.7; -7.1; -11.5; -4.3; 4.2; -6.6; -6.5; -6.6; -7.2; -7.5; -7.7; -9.2; -9; -9.2.
- Endogenous debt dynamics: -1.0; -2.9; 1.6; 0.9; 0.0; 0.1; 0.1; 0.1; 0.0; -0.1; -0.1.
  - Contribution from nominal interest rate: 0.2; 0.4; 0.5; 0.7; 0.7; 0.9; 1.0; 0.9; 0.9; 0.4; 0.1.
  - Contribution from real GDP growth: 0.3; -0.5; 0.1; 0.2; -0.7; -0.8; -0.9; -0.9; -0.8; -0.5; -0.2.
- Residual (3-4): -3.4; -0.4; 2.3; 1.9; -6.0; -10.5; -11.6; -11.0; -8.1; -3.5; -2.9.
- PV of external debt (in percent of GDP, selected years): 23.7; 34.1; 39.8; 41.8; 40.9; 38.4; 35.8; 23.4; 8.1.
  - In percent of exports (selected years): 170.7; 219.8; 249.7; 261.2; 257.3; 243.2; 228.2; 144.9; 50.2.
- Debt service-to-exports ratio (in percent): 9.8; 10.0; 8.7; 8.8; 10.5; 11.2; 11.6; 16.6; 17.5; 16.4; 7.1.
- Total gross financing need (Millions of U.S. dollars): 10.9; 10.3; 11.3; 33.4; 43.1; 45.0; 38.5; 35.9; 27.7; 16.0; 22.9.
- Non-interest current account deficit that stabilizes debt ratio: 10.1; 10.4; 7.6; 3.8; 12.5; 17.1; 18.7; 18.4; 15.8; 12.8; 12.3.

### Key macroeconomic assumptions (selected)
- Real GDP growth (in percent) series: -1.2; 2.0; -0.4; 1.4; 1.9; -0.5; 1.7; 1.7; 1.8; 1.8; 1.8; 1.4; 1.8; 1.8; 1.8.
- GDP deflator in US dollar terms (change in percent): 5.7; 11.5; -3.9; 4.2; 9.0; -9.2; 0.9; 1.4; 2.8; 3.9; 2.9; 0.5; 2.9; 2.9; 2.9.
- Effective interest rate (percent): 0.9; 1.5; 1.9; 1.0; 0.5; 2.1; 1.7; 1.9; 1.9; 1.9; 1.9; 1.9; 1.4; 1.1; 1.4.
- Growth of exports of G&S (US dollar terms, in percent): -19.8; 50.6; -7.4; 6.5; 25.1; 1.0; 5.3; 3.6; 3.8; 4.9; 4.3; 3.8; 4.7; 4.7; 4.9.
- Growth of imports of G&S (US dollar terms, in percent): -6.1; 22.2; -3.0; 10.1; 12.8; -7.6; 11.7; 4.4; 4.3; 5.4; 2.9; 3.5; 5.2; 4.7; 4.8.
- Grant element of new public sector borrowing (in percent, selected years): 20.3; 19.5; 22.8; 28.6; 41.6; 41.6; 29.1; 41.5; 41.0; 41.3.
- Government revenues (excluding grants, in percent of GDP): 24.6; 24.9; 17.4; 18.7; 18.8; 19.7; 20.1; 20.3; 21.5; 21.3; 21.9; 21.5.
- Aid flows (Millions of US dollars) total: 11.3; 4.6; 21.6; 20.8; 31.5; 25.6; 22.0; 23.0; 13.9; 15.6; 23.5.
  - o/w Grants (Millions of US dollars): 11.3; 4.6; 21.6; 19.5; 31.5; 23.6; 20.0; 19.0; 9.9; 11.6; 19.5.
  - o/w Concessional loans (Millions of US dollars): 0.0; 0.0; 0.0; 1.3; 0.0; 2.0; 2.0; 4.0; 4.0; 4.0; 4.0.
- Grant-equivalent financing (in percent of GDP, selected): 9.0; 11.6; 8.5; 6.5; 5.9; 3.2; 2.9; 2.9; 2.9.
- Grant-equivalent financing (in percent of external financing, selected): 49.0; 69.4; 71.6; 85.9; 89.7; 83.1; 84.8; 89.7; 86.3.

### Sensitivity analyses and stress tests (selected)
- Baseline PV of PPG external debt (in percent of GDP): 34; 40; 42; 41; 38; 36; 23; 8 (years 2010–2030).
- Alternative scenario A2 (New public sector loans on less favorable terms in 2010-2030) PV of debt-to-GDP: 34; 42; 45; 44; 42; 40; 29; 15.
- Bound test B6 (One-time 30 percent nominal depreciation relative to the baseline in 2011) PV of debt-to-GDP: 34; 58; 60; 59; 55; 52; 34; 12.
- PV of debt-to-exports ratio baseline: 220; 250; 261; 257; 243; 228; 145; 50.
  - Under B2 (Export value growth shock) PV of debt-to-exports: 220; 347; 502; 494; 469; 445; 300; 112.
- PV of debt-to-revenue ratio baseline: 183; 212; 212; 203; 189; 166; 110; 37.
  - Under B6 (30 percent depreciation) PV of debt-to-revenue: 183; 306; 307; 293; 272; 241; 159; 54.
- Debt service-to-exports ratio baseline (selected years): 9; 10; 11; 12; 17; 18; 16; 7.
- Grant element assumed on residual financing (memorandum): 36 (applies to all stress scenarios except A2).

### Public sector debt indicators (selected)
- Public sector debt (percent of GDP): 37.3; 33.9; 38.6; 51.4; 57.1; 58.5; 55.8; 51.6; 47.6; 36.3; 16.1.
  - o/w foreign-currency denominated: 27.1; 25.3; 31.5; 44.2; 50.7; 52.8; 51.2; 47.9; 44.8; 29.4; 11.6.
- Change in public sector debt: -2.3; -3.4; 4.7; 12.7; 5.7; 1.4; -2.7; -4.1; -4.0; -2.2; -1.8.
- Identified debt-creating flows (public sector): -4.2; -5.9; 8.4; 5.1; 5.8; 3.0; 2.6; -0.2; -1.4; -1.9; -1.8.
- Primary deficit (percent of GDP): -1.6; -2.1; 2.6; 0.0; 1.9; 2.9; 3.9; 3.4; 3.9; 1.6; 0.2; 2.6; -0.8; -1.3; -0.9.
- Revenues and grants (percent of GDP): 28.3; 26.3; 24.0; 25.3; 29.2; 27.2; 26.2; 25.7; 24.3; 23.8; 24.6.
  - of which: grants (percent of GDP): 3.7; 1.3; 6.6; 6.6; 10.4; 7.5; 6.1; 5.5; 2.7; 2.5; 2.7.
- Primary (noninterest) expenditure (percent of GDP): 26.7; 24.1; 26.6; 28.2; 33.0; 30.6; 30.1; 27.4; 24.5; 23.0; 23.3.
- PV of public sector debt (percent of GDP): 10.2; 8.6; 30.9; 41.3; 46.2; 47.6; 45.5; 42.1; 38.7; 30.3; 12.6.
  - o/w foreign-currency denominated (percent of GDP): 23.7; 34.1; 39.8; 41.8; 40.9; 38.4; 35.8; 23.4; 8.1 (selected years).
- Gross financing need: -0.2; -0.4; 4.6; 5.5; 6.5; 6.0; 7.0; 5.2; 3.9; 2.4; 1.0.
- PV of public sector debt-to-revenue and grants ratio (percent): 36.1; 32.8; 128.6; 163.5; 158.5; 174.9; 173.7; 163.5; 159.4; 127.1; 51.2.
- Debt service-to-revenue and grants ratio (percent): 4.7; 6.5; 8.4; 10.2; 8.8; 9.5; 11.7; 13.8; 15.1; 13.5; 9.3.
- Primary deficit that stabilizes the debt-to-GDP ratio (percent): 0.8; 1.2; -2.1; -9.8; -1.9; 2.0; 6.6; 5.8; 4.2; 1.4; 0.5.

### Executive Board assessment and recommendations (from Public Information Notice No. 10/57, May 12, 2010)
- Near-term outlook:
  - Growth expected to reach 1¾ percent in FY2010/11 on the back of increased construction activity, tourism, and remittances.
  - Activity estimated to fall in FY2009/10 by ½ percent due to delays in capital projects, low domestic value added from China reconstruction loan spending, lower tourism and remittances, and contracted bank lending.
  - Consumer price inflation fell to 1½ percent y/y in January 2010; 2009/10 inflation expected to average 2¼ percent.
- Risks and constraints:
  - Medium-term growth constrained by geographic isolation, narrow export base, high cost of labor, inability to retain skilled labor, and impediments to private sector activity.
  - Increase in external and public debt has left the economy more vulnerable to shocks; Tonga classified in the range of “high risk of debt distress.”
- Fiscal policy recommendations:
  - Maintain sustained effort to put public debt on a downward path.
  - Step up revenue administration and expenditure control.
  - Prioritize expenditure and limit loan drawdown to finance productive projects.
  - Establish a comprehensive debt management strategy to limit credit and currency risks in the government balance sheet.
  - Encourage continued donor grants; if grants are lower than expected, implement further fiscal restraint and possibly redirect spending toward higher priority projects.
- Monetary and exchange rate recommendations:
  - Maintain a neutral monetary policy stance in months ahead given liquidity risks feeding inflation and downward pressure on reserves.
  - Tighten monetary policy using NRBT’s tools if risks of higher inflation or reserve pressures materialize.
  - Limit use of direct credit controls to minimize distortions.
  - Stand ready to gradually depreciate against the basket to safeguard external stability, accompanied by fiscal restraint.
- Financial sector and structural recommendations:
  - Continue strengthening bank supervision and disclosure of full loan costs.
  - Improve legal framework for collateralized borrowing to lower intermediation costs.
  - Streamline business licensing, lower barriers to foreign investment, and improve institutional framework for lending to increase access to finance and lower cost of borrowing.
  - Resist pressure to administer interest rates to avoid credit rationing and hamper banks’ ability to price risk.

### Selected macro-financial headline figures (from Tonga: Selected Economic Indicators)
- Nominal GDP (2008/09): US$ 328.4 million.
- Population (2006): 101,991.
- GDP per capita (2008/09): US$ 3,220.
- Real GDP (annual percent change): 0.5; -1.2; 2.0; -0.4; -0.5; 1.7 (2005/06–2010/11 series).
- Consumer prices (period average): 7.0; 5.1; 9.8; 5.0; 2.2; 4.2.
- Total revenue and grants (percent of GDP): 26.6; 28.3; 26.3; 24.0; 25.3; 29.2.
- Total expenditure and net lending (percent of GDP): 29.4; 27.3; 24.7; 27.3; 29.2; 34.3.
- Overall balance (percent of GDP): -2.8; 1.1; 1.5; -3.3; -3.9; -5.1.
- Current account balance (Millions of US dollars): -22.8; -25.5; -30.9; -46.9; -51.5; -60.5.
  - Current account balance (in percent of GDP): -7.9; -8.4; -9.0; -14.3; -17.4; -19.9.
- Gross official foreign reserves (Millions of US dollars): 40.4; 47.1; 48.2; 67.7; 70.6; 72.0.
  - In months of goods and services imports: 3.1; 3.9; 3.2; 4.7; 5.3; 4.8.
- External debt (percent of GDP): 29.0; 27.1; 25.3; 31.5; 44.2; 50.7.
- Debt service ratio: 1.1; 1.1; 1.4; 1.2; 1.1; 1.5.
- Nominal GDP (millions of T$) memorandum: 580.1; 604.1; 652.2; 685.0; 704.9; 747.1.

*Sources: Country authorities; and staff estimates and projections. Public Information Notice No. 10/57 (May 12, 2010).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10112.pdf_