Tonga: Staff Concluding Statement of the 2022 Article IV Mission

IMF News, May 13, 2022

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Tonga: Staff Concluding Statement of the 2022 Article IV Mission

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• Published: May 13, 2022

Recent economic developments and shocks

• Tonga’s economic activity is slowly normalizing following the Hunga Tonga Hunga Haʻapai (HTHH) volcanic eruption and the local outbreak of COVID-19 in early 2022.
• The volcanic eruption and the COVID-19 outbreak put virtually all activities to a halt in Q1 2022; tourism facilities were particularly hit and agriculture suffered from volcanic ashfalls.
• Reconstruction and ash clean-up are underway with international humanitarian aid and financial assistance.
• Headline inflation averaged 7.8 percent (y/y) from July 2021 to March 2022, above the NRBT’s reference rate of 5 percent.
• IMF-staff estimate of core inflation (excluding food and energy) at end-March 2022: 3.4 percent (after peaking at 4.2 percent in June 2021).
• Fiscal balance switched to a deficit in FY2021: surplus of 5.3 percent of GDP in FY2020 to a deficit of 0.9 percent in FY2021 after a fiscal package worth 5.3 percent of GDP.
• Current account balance (CAB) estimated to have pivoted from -3.9 percent of GDP in FY2020 to 2.6 percent in FY2021, driven by remittances (increase of 36 percent in FY2021) and grants.
• IMF Rapid Credit Facility financial assistance: US$9.7 million (50 percent of quota).
• FX reserves: US$318 million in FY2021 and US$360 million as of end-December 2021 (partly reflecting IMF’s 2021 SDR allocation of US$18.7 million in August 2021).

Outlook and key macro projections (selected)

• Real GDP:
  • FY2021: -2.7
  • FY2022: -1.9 (projected)
  • FY2023: 3.2 (projected)
  • FY2024: 3.0 (projected)
• Inflation (consumer prices, period average):
  • FY2021: 1.4
  • FY2022: 8.2 (projected)
  • FY2023: 4.4 (projected)
  • FY2024: 2.0 (projected)
• Short-term assumptions underlying outlook:
  • Meaningful tourism recovery expected to be delayed to FY2024 despite border reopening plans over FY2023.
  • Acceleration of flagship reconstruction projects in FY2023 after borders reopen in July.
  • Crop production gradual recovery over FY2023–FY2024 as soil contamination dissipates.
• Balance of payments projections and risks:
  • CAB projected to switch to a deficit of -6.1 percent of GDP in FY2022 and deteriorate to -22.4 percent in FY2023 under baseline.
  • Deterioration driven by increased food imports, reconstruction-related imports, subdued tourism, lower agricultural exports, and decline in remittances from exceptional FY2021 levels.
  • External financing gap exists under current grant commitments.
• Balance of risks: tilted to the downside (natural disasters, further rise in international food and energy prices including war in Ukraine, faster local COVID-19 transmission, loss of correspondent banking relationships).

Fiscal policy stance and recommendations

• Donor pledges since the disaster: additional budget support worth 6.7 percent of GDP for FY2022 and 3.6 percent of GDP for FY2023 in grants.
• Staff expect fiscal deficit to widen from 0.4 percent of GDP in FY2021 to 1.4 percent in FY2022 despite donor support.
• FY2023: envisaged expansionary fiscal stance supported by staff to finance reconstruction and social spending; capacity for capital investment expected to improve as borders reopen in FY2023.
• Medium-term fiscal strategy:
  • Combine domestic fiscal measures and additional donor support to meet development spending needs and reduce debt distress risk.
  • Avoid new non-concessional borrowing from external creditors; pursue additional grants from development partners.
• Revenue and expenditure reform priorities:
  • Revenues: potential increase of about 3 percent of GDP by reducing tax exemptions and strengthening tax administration. IMF TA report estimate: additional revenue of 2½ percent of GDP by removing major tax exemptions (notably related to electricity); revenue administration reforms could increase revenues by ½-1 percent of GDP.
  • Expenditures: compensation of employees has exceeded the fiscal anchor of 53 percent of domestic revenue since FY2021; goods and services spending in Tonga 12 percent of GDP versus median PICs 11 percent of GDP. Lowering wages and goods and services to peer levels could improve fiscal balance by about 1½ percent of GDP.
• Transparency: continue strengthening cash and financial management information systems and internal audit; pandemic-related spending should be closely monitored, audited, and reported in a timely manner. IMF stands ready to provide CD support for implementing commitments under the RCF emergency financial assistance.

Monetary, exchange rate, and financial sector policy guidance

• Monetary stance: NRBT maintained policy rate at zero percent, statutory reserve deposit (SRD) ratio at 10 percent, and inflation reference rate at five percent.
• Staff view: current settings appropriate under baseline but NRBT should stand ready to tighten if inflation remains above the reference rate—options include increasing the SRD ratio or raising the policy rate.
• Exchange rate: nominal exchange rate pegged to a basket; real effective exchange rate appreciated by 4.7 percent since January 2021.
• Banking sector:
  • Banks were profitable and well-capitalized pre-eruption, with declining NPLs; bank credit declined since mid-2020.
  • Staff recommendations:
  • Encourage banks to actively provision for potential loan losses and monitor credit risks, especially in tourism, wholesale and retail, transport, and agriculture.
  • If capital buffers become inadequate, consider restricting dividend payouts and request capital injections from parent banks.
• Financial sector reform priorities:
  • (i) risk-based offsite supervision; (ii) expand NRBT remit to cover NBFIs (insurance, pension funds); (iii) establish a solvency stress testing framework covering NBFI lending with IMF CD; (iv) develop macroprudential instruments and a systematic approach to macrofinancial risks. NRBT plans to establish a Financial Stability Unit.
• Credit access and inclusion:
  • Near-term: provide targeted concessional credit to MSMEs via Government Development Loan (GDL) Scheme (expanded from T$13 million to T$18.3 million in 2020); subsidized interest rate reduced to 1 percent from 3 percent for new loans.
  • Consider partial loan guarantee scheme.
  • Long-term: improve credit information systems, strengthen insolvency regimes, establish credit registry within NRBT and expand to include NBFIs.
  • Address high remittance transaction costs; promote financial solutions such as the Ave Pa’anga Pau voucher system.

Structural reforms and governance

• Climate resilience:
  • Top priority to enhance disaster and climate resilience.
  • Implement Disaster Risk Management bill (passed 2021) and improve coordination across ministries.
  • Improve efficiency of climate-resilience capital spending via a comprehensive public asset register and expanded classification of capital spending; IMF CD on Asset Management Framework.
  • Revise Building Code for climate resilience and strengthen enforcement.
• Private sector development:
  • Amend reserved and restricted industries under draft Foreign Investment Regulation 2021 to realize benefits from the Foreign Investment Act of 2020.
  • Additional initiatives: enhance access to credit, expand/upgrade physical and ICT infrastructure (including island internet connectivity), increase spending on health, education, social protection, and improve land leasehold market operations.
• Anti-corruption and AML/CFT:
  • Tonga acceded to the United Nations Convention Against Corruption in February 2020; implement Anti-Corruption Commissioner Act (enacted 2017 but office not yet set up).
  • Address weaknesses identified in 2021 Tax Administration Diagnostic Assessment Tool (tax dispute resolution, ease of paying tax).
  • Progress on AML/CFT: establishment of Financial Analysis and Supervision Coordinating Unit; enhanced FIU collaboration and national know-your-customer system; NRBT seeking to revise AML/CFT framework to be more risk-based and aligned with APG recommendations.

Debt, reserves, and vulnerabilities

• Tonga assessed at high risk of debt distress.
• Without additional grant commitments to staff’s baseline projection, present value of public debt-to-GDP projected to rise above the 70 percent debt-distress benchmark in FY2032.
• Public debt composition: largely external; over half of total public debt is to China Exim Bank.
• Debt service: repayments expected to pick up in FY2024, mainly to Exim Bank, and stay elevated at over 3 percent of GDP until FY2027.
• Selected indicators from Table 1 (FY2019–FY2024 where shown):
  • Population (2020): 106 thousands
  • Quota: SDR 13.2 million
  • Remittances (in percent of GDP): FY2020 40.7; FY2021 36.1; FY2022 29.0 (projected)
  • Gross official foreign reserves (millions of U.S. dollars): FY2021 317.9; FY2022 323.3; FY2023 221.3 (projected); FY2024 119.3 (projected)
  • Gross official foreign reserves (months of next year's total imports): FY2021 9.2; FY2022 3.6; FY2023 (projection) 3.6 (table shows 3.6 for FY2022)
  • Public debt (external and domestic, percent of GDP): FY2021 45.7; FY2022 43.2 (projected); FY2023 42.8 (projected); FY2024 42.8 (projected)
  • Current account balance (percent of GDP): FY2020 -3.9; FY2021 2.6; FY2022 -6.1 (projected); FY2023 -22.4 (projected); FY2024 -20.0 (projected)
  • Nominal GDP (millions of US$): FY2021 489.5; FY2022 519.6 (proj); FY2023 554.4 (proj); FY2024 582.2 (proj)

Source: Tonga: Staff Concluding Statement of the 2022 Article IV Mission (May 13, 2022), IMF.

References

• PRESS CENTER
• [IMF Report on the Pacific Roundtables: Actions to Address Correspondent

Banking and Remittance Pressure, 2019](https://www.elibrary.imf.org/view/journals/087/2019/006/087.2019.issue-006-en.xml)

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