Tonga: Staff Concluding Statement of the 2024 Article IV Mission

IMF News, August 25, 2024

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Tonga: Staff Concluding Statement of the 2024 Article IV Mission

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Bibliographic details

• Published: August 25, 2024
• DOI: https://doi.org/10.5089/9798400216855.002

Executive summary

• Economic activity strengthened driven by construction, strong remittances, and a recovery in tourism with real GDP projected to accelerate to 2.4 percent in FY2025, supported also by a recovery in agricultural output.
• Elevated frequency of natural disasters, supply-side constraints, and geographical remoteness temper the medium-term outlook.
• Inflation has moderated from its highs; projected to decline further as El Nino effects on local food prices dissipate.
• Short-term: expansionary fiscal stance appropriate; primary balance ex-grants expected to mildly deteriorate in FY2025.
• Medium-term: gradual and credible fiscal consolidation and additional grant financing commitments warranted to put debt on a firm downward path.
• Financial sector: promote financial deepening while safeguarding stability through expanded macroprudential toolkit, regular stress tests, and strengthened prudential standards.
• Structural reforms: bolster disaster resilience, advance digital transformation, and strengthen governance frameworks to foster a conducive business environment.

Macroeconomic developments and outlook

• Recent developments
  • FY2023 real GDP growth estimated at 2.0 percent; FY2024 GDP estimated to have expanded at 1.8 percent despite a ½ percentage point drag from agricultural production.
  • Headline inflation: peaked at 14.1 percent in September 2022; bottomed at 3.2 percent year-over-year in March 2024; reached 5.4 percent in June 2024 driven by a 24 percent surge in local food prices.
  • IMF-calculated core inflation reached 1.2 percent in June 2024; imported component of inflation rose by 0.8 percent.
  • Credit: total lending grew by 4.1 percent (y/y) at end-June 2024; household lending up 6.0 percent; business lending up 2.2 percent.
  • Banking system liquidity ample; interest rates remained flat.

• Outlook and risks
  • Near-term projection: real GDP projected to accelerate to 2.4 percent in FY2025, led by domestic demand and large public investment projects (Funga’uta Lagoon Bridge and Nuku’alofa port upgrade) and agricultural rebound as El Nino dissipates.
  • Inflation outlook: expected to moderate below the 5 percent reference rate in FY2025 and onward.
  • Medium-term growth: long-term growth projected at 1.2 percent.
  • Downside risks: frequent natural disasters; a deterioration in bank asset quality; further loss of correspondent banking relationships (CBRs) in the region due to AML/CFT weaknesses; faster-than-expected outflows of Tongan workers; global slowdown.
  • Upside possibilities: faster tourism recovery, stronger agricultural exports, stronger grants and construction activity.
  • External position: FY2024 preliminarily assessed as broadly in line with fundamentals; current account deficit widened from 6.6 percent of GDP in FY2023 to 7.4 percent in FY2024.
  • Reserves: adequate, covering 10.6 months of imports in FY2024, supported by grants.
  • Debt: Tonga assessed as remaining at high risk of debt distress; without additional grant commitments, PV of external and public debt-to-GDP ratios projected to keep rising and cross the 55 percent threshold and the 70 percent benchmark in FY2034. Debt repayments surged to 3.5 percent of GDP in FY2024 and remain elevated at over 3.0 percent of GDP until FY2027.

Policy recommendations — Fiscal policy

• Short-term
  • Current expansionary fiscal stance appropriate; excluding grants, FY2024 fiscal impulse about 2 percent of GDP; expected to moderate to about 0.5 percent of GDP in FY2025.
  • Overall fiscal balance estimated surplus in FY2024 at 3.5 percent of GDP due to record-high grant inflows and stronger tax revenues.
  • IMF staff projects the fiscal balance to revert to a deficit of 8.0 percent of GDP in FY2025 as external grants return to historical trend while reconstruction expenditures remain strong.
  • Authorities should consider cutting spending unrelated to reconstruction, including limiting the public sector wage bill which is expected to cross the 53 percent limit as share of domestic revenues following the 15 percent expected increase in public sector wage bill in FY2025—because of a 5 percent public sector wage increase (cost of living adjustment) and filling up vacancies.

• Medium-term
  • Gradual and credible medium-term fiscal consolidation and additional grant financing commitments warranted.
  • Three-prong fiscal adjustment approach: domestic revenue mobilization (including gradual increase in tax revenues), enhancing spending efficiency, and securing additional grants.
  • Specific measures: remove tax-inefficient exemptions without increasing statutory rates, improve tax administration, restrain the public wage bill, rationalize low-priority current expenditures, and secure additional grants from development partners.
  • Strengthen fiscal rules: articulate rule’s rationale, strengthen enforcement, improve institutional processes and fiscal reporting, introduce an escape clause, focus on total current expenditure (not just wages), and consider provisions for building fiscal buffers for disaster shocks.

Policy recommendations — Monetary policy

• Current stance and conditional tightening
  • Current stance appropriately accommodative as consumer price inflation expected to stabilize below the 5 percent reference rate.
  • NRBT measures: February 2023 increase in statutory reserve deposit (SRD) ratio from 10 percent to 15 percent; policy rate (rate on excess bank reserves) unchanged at zero percent.
  • If demand-driven domestic inflation pressures resurface, monetary policy tightening warranted, including by raising the policy rate (floor interest rate paid on excess reserves). Raising the policy rate would also create room to lower it if downside risks materialize (e.g., a major natural disaster).

• Framework strengthening
  • Opportunity with forthcoming NRBT Act amendments to: redefine preferred inflation measure focusing on a core measure excluding volatile energy and food prices; adopt more proactive use of the policy rate; enhance NRBT communication (e.g., publish regular board meeting dates).
  • Clarify operational guidelines for transfer of profits, coverage of losses, and recapitalization consistent with the 2021 IMF safeguards assessment and TA recommendations.
  • Ensure amendments do not impair NRBT financial autonomy.

Policy recommendations — Financial sector policies

• Banking sector condition
  • Capital adequacy strong at 32.1 percent as of June 2024, above the 15 percent regulatory requirement.
  • NPL ratio increased from 7.4 percent in 2023Q1 to 11.2 percent at end-June 2024, mostly driven by business loans.
  • Systemic risk largely contained given major banks are well capitalized subsidiaries of sizable foreign institutions.

• Recommended actions
  • Continue regular stress tests; ensure banks maintain sufficient capital.
  • Strengthen prudential standards and regulations (e.g., for credit unions and provisioning).
  • Avoid frequent staff turnover in supervisory agencies.
  • Expand scope and increase frequency of data collection to enable risk-based supervision.
  • Broaden NRBT regulatory and supervisory remit to cover non-bank financial institutions (NBFIs) including retirement funds.
  • Issue domestic government bonds to promote domestic interbank markets and financial deepening.

Policy recommendations — Structural reforms

• Disaster resilience and climate
  • Prioritize enhancing resilience to natural disasters and climate change.
  • Disaster Risk Management bill enacted in 2023 pivots focus toward ex-ante risk mitigation and preparedness.
  • Expand classification of climate change-related spending and strengthen social protection.

• Governance and private sector
  • Address macro-critical governance vulnerabilities: enhance fiscal governance (revenue institutions, procurement, fiscal transparency, PFM controls) and strengthen AML/CFT frameworks (preventive measures, entity transparency, criminal justice).
  • The appointment of the first anti-corruption commissioner in July 2024 noted as a welcome development.
  • Private sector development: digitalization (national digital ID system) to overcome geographical limits, facilitate social assistance delivery, enhance access to credit via improved customer due diligence, and leverage mobile money.
  • Other measures: better allocate increased government spending on education and training; improve women’s access to credit; tackle regulatory restrictions to attract FDI; modernize and clarify land lease process to improve transparency and ownership clarity.

Capacity development

• IMF technical assistance
  • Tonga is a major recipient of IMF TA in the region with strong ownership and capacity to absorb TA.
  • Recent TA areas: monetary policy operations, PFM, tax policy, government finance statistics, revenue administration, macroeconomic frameworks and nowcasting, and AML/CFT and financial stability frameworks.
  • Strengthening data adequacy for surveillance is a high priority—especially external, fiscal, and national accounts statistics.

Key statistics and projections (selected)

• Population (2021): 100 thousands
• Major exports: root crops, vanilla, squash, fish

• Output and prices (Annual percent change)
  • Real GDP: FY2022 0.0; FY2023 2.0; FY2024 1.8; FY2025 2.4
  • Consumer prices (period average): FY2022 8.5; FY2023 10.2; FY2024 4.6; FY2025 3.2; FY2026 3.0
  • Consumer prices (end of period): FY2022 11.3; FY2023 7.4; FY2024 5.4; FY2025 2.9

• Central government finance (In percent of GDP)
  • Revenue: FY2022 47.3; FY2023 53.5; FY2024 52.5; FY2025 41.5; FY2026 38.9
  • of which: Grants: FY2022 19.9; FY2023 27.6; FY2024 26.7; FY2025 15.8; FY2026 13.0
  • Expenditure: FY2022 48.1; FY2023 47.4; FY2024 49.0; FY2025 49.5; FY2026 48.5
  • Expense: FY2022 42.0; FY2023 39.6; FY2024 37.2; FY2025 38.6
  • Net acquisition of nonfinancial assets: FY2022 6.1; FY2023 7.8; FY2024 11.8; FY2025 10.9
  • Primary balance: FY2022 -0.2; FY2023 6.7; FY2024 3.9; FY2025 -7.5; FY2026 -9.1
  • Overall balance: FY2022 -0.7; FY2023 6.0; FY2024 3.5; FY2025 -8.0; FY2026 -9.6
  • Overall balance (excl. grants): FY2022 -20.7; FY2023 -21.5; FY2024 -23.3; FY2025 -23.7; FY2026 -22.6

• Money and credit
  • Broad money (M2): FY2022 13.4; FY2023 -0.3; FY2024 1.7; FY2025 3.7; FY2026 5.0
  • Domestic credit: FY2022 -3.3; FY2023 -15.6; FY2024 38.5; FY2025 5.8; FY2026 14.5
  • Private sector credit (selected): FY2023 9.0; FY2024 6.8; FY2025 4.5

• Balance of payments (In millions of U.S. dollars; and percent of GDP)
  • Current account balance (millions of U.S. dollars): FY2022 -32.4; FY2023 -34.6; FY2024 -40.3; FY2025 -44.3; FY2026 -46.8
  • Current account balance (percent of GDP): FY2022 -6.8; FY2023 -6.6; FY2024 -7.4; FY2025 -7.8; FY2026 -7.9
  • Exports of goods, f.o.b. (millions): FY2022 15.1; FY2023 13.1; FY2024 12.9; FY2025 15.7; FY2026 18.1
  • Imports of goods, f.o.b. (millions): FY2022 216.1; FY2023 235.4; FY2024 257.3; FY2025 271.8; FY2026 280.3
  • Tourism receipts (millions): FY2022 9.9; FY2023 43.9; FY2024 49.9; FY2025 55.0; FY2026 62.1
  • Total remittances (millions): FY2022 215.9; FY2023 256.0; FY2024 263.1; FY2025 274.2; FY2026 285.2
  • Compensation of overseas workers (millions): FY2022 35.3; FY2023 55.3; FY2024 59.2; FY2025 62.3; FY2026 66.5
  • Personal remittances (millions): FY2022 180.6; FY2023 200.6; FY2024 203.9; FY2025 211.9; FY2026 218.7
  • Official grants (millions): FY2022 24.6; FY2023 22.9; FY2024 29.1; FY2025 23.8

• Capital and financial accounts
  • Capital account balance (millions): FY2022 73.2; FY2023 66.1; FY2024 17.2; FY2025 7.3
  • Financial account balance (millions): FY2022 29.5; FY2023 17.6; FY2024 -17.5; FY2025 44.7; FY2026 54.4

• Reserves and debt
  • Gross official foreign reserves (millions of U.S. dollars): FY2022 378.5; FY2023 388.8; FY2024 386.2; FY2025 403.8; FY2026 418.8
  • Reserves (months of next year's total imports): FY2022 11.2; FY2023 10.6; FY2024 10.7
  • Public debt (external and domestic, percent of GDP): FY2022 47.5; FY2023 43.3; FY2024 37.8; FY2025 44.0; FY2026 51.8
  • External debt (percent of GDP): FY2022 41.3; FY2023 32.3; FY2024 38.0; FY2025 45.0
  • External debt service ratio: FY2022 1.5; FY2023 2.2; FY2024 3.8; FY2025 3.6

• Exchange rates and GDP
  • Exchange rate (National currency per US dollar): FY2022 2.3
  • Real effective exchange rate (2010=100): FY2022 115.7; FY2023 125.4; FY2024 127.9
  • Nominal GDP (millions of US$): FY2022 475.4; FY2023 520.3; FY2024 545.4; FY2025 571.6; FY2026 595.7

Source: IMF mission staff concluding statement, "Tonga: Staff Concluding Statement of the 2024 Article IV Mission."

References

• Tonga and the IMF
• IMF Policy Advice -- A Factsheet
• Mission Concluding Statements
• PRESS CENTER
• [[1]](https://www.imf.org/en/news/articles/2024/08/23/EditorPage.aspx?da=core&di=0&ed=FIELD58224000&fbd=1&fld=%7B5E30EA8C-0335-4122-B707-513176E32724%7D&hdl=H58224101&id=%7B93838C2E-A523-4408-86C5-3F4C4E38D9D9%7D&la=en&mo=&pe=0&so=%2Fsitecore%2Fsystem%2FSettings%2FHtml+Editor+Profiles%2FRich+Text+Full&vs=)
• IMF-World Bank 2021 Climate Change Policy Assessment Report
• https://www.imf.org/en/home