Tonga: Staff Concluding Statement of the 2025 Article IV Mission

IMF News, August 25, 2025

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Published: August 25, 2025

I. Recent developments, outlook, and risks

Growth and drivers
- GDP growth in FY2025 was revised upward to 2.7 percent due to stronger-than-expected grant inflows, elevated remittances, a rebound in tourism, and fiscal support for reconstruction.
- Growth is projected to moderate to 2.3 percent in FY2026, supported by robust domestic demand from major infrastructure projects.
- Potential growth is estimated at 1.2 percent over the medium term, reflecting high vulnerability to natural disasters, persistent outward migration, and limited economies of scale.
Inflation and prices
- Headline inflation eased to 1.4 percent in June 2025, below the 5 percent NRBT reference rate, reflecting lower food and energy prices.
- Core inflation rose to 9.9 percent, driven by higher prices for beverages, clothing, and restaurant and hotel services; core inflation is expected to decline only gradually toward headline over the medium term.
- Annual inflation for FY2025 is estimated at 2.9 percent.
Fiscal position
- Overall fiscal balance posted a surplus of 5.6 percent of GDP in FY2025, supported by record-high grants of about 32 percent of GDP, increased domestic revenues, and temporary wage savings from slower public-sector vacancy refilling.
- Using only firmly committed grants, while reconstruction spending remains elevated, the fiscal balance is projected to shift to a deficit of 7.7 percent of GDP in FY2026.
External sector and reserves
- Current account deficit widened from 3.8 percent of GDP in FY2024 to 5.2 percent in FY2025 due to higher goods imports despite elevated remittances.
- Tonga’s external position in FY2025 is preliminarily assessed to be broadly in line with the level implied by medium-term fundamentals and desirable policies.
- Foreign exchange reserves are estimated to remain stable and adequate at the end of FY2025; exchange rate stability maintained under the current currency regime.
Financial sector and credit
- Private credit rose by 9.6 percent year-on-year as of June 2025, driven by a 22.9 percent surge in business lending; household credit remained more subdued.
- Ample bank liquidity has kept credit supply responsive and interest rates stable.
- The financial system remains well capitalized and liquid, though non-performing loans (NPLs) have risen; earlier sharp increase reflected large exposures of a single institution, more recent rises stem from pressures in the transport sector.
Risks
- Downside risks: steeper slowdown in global growth, escalating geopolitical tensions, possible reduction in concessional financing, natural disasters, delays in reconstruction and donor-financed projects, accelerated outmigration, further loss of correspondent banking relationships (CBRs), and rising banking sector vulnerabilities.
- Upside risks: stronger tourism recovery and higher-than-expected grants.

II. Policies to rebuild buffers and enhance economic resilience

A. Fiscal policy — Pivot toward fiscal restraint to rebuild buffers

Key assessments and projections
- FY2025 expansionary fiscal stance appropriately supported recovery, but rebuilding buffers is now important given stronger economic footing.
- Tonga is assessed as being at high risk of debt distress; long-term debt ratios projected to rise above key thresholds under baseline assumptions.
Policy recommendations
- Refrain from contracting new non-concessional borrowing.
- Implement gradual and credible fiscal consolidation over the medium term, underpinned by:
- Boosting domestic revenue mobilization, including removing tax-inefficient exemptions without increasing statutory rates.
- Improving tax administration.
- Enhancing spending efficiency.
- Securing additional grants, particularly through strengthened regional collaboration.
- Recognize that excluding grants, the fiscal stance is expected to turn contractionary in FY2026, consistent with staff recommendations and authorities’ intentions to rebuild buffers.

B. Monetary and financial sector policies — Strengthen monetary stability and foster a stable and inclusive financial system

Monetary stance and tools
- Accommodative monetary policy has supported recovery; with emerging price pressures and ample liquidity, shift toward a neutral stance is appropriate.
- Policy rate—defined as the floor interest rate paid on reserves—remains at zero.
- The NRBT’s plan to issue short-term securities will absorb excess liquidity and help stimulate development of an interbank market.
- Transitioning to a corridor-type framework, in line with recent IMF TA, will strengthen liquidity management and create space to adjust the policy rate from zero.
- Introduction of notes with positive yields should be seen as establishing market infrastructure and moving toward a neutral stance, not as signaling a contractionary shift.
Operational and governance enhancements
- NRBT could redefine its preferred inflation measure by focusing on a core measure that excludes volatile energy and food prices.
- Adopt a more proactive use of the policy rate supported by enhanced communication (for example, publishing regular board meeting dates).
- NRBT and the government should consider clarifying operational guidelines for transfer of profits, coverage of losses, and recapitalization, consistent with the 2021 IMF safeguards assessment and TA recommendations.
Financial sector stability and reforms
- Continue reforms to promote financial deepening and stability, including:
- Stronger supervision of Non-Bank Financial Institutions (NBFIs).
- Expansion of the credit registry.
- Finalization of regulatory frameworks for credit unions and pension funds.
- Enhanced AML/CFT enforcement to help safeguard correspondent banking ties.
- Participation in regional initiatives such as the World Bank correspondent banking relationships project and the Fund’s Safe Payment Corridor is encouraged.
- Over time, broader prudential standards and data collection will underpin sustainable financial deepening and effective risk-based supervision.

C. Structural reforms — Lift up potential growth and enhance economic resilience

Private sector and labor
- Priorities to lift long-term growth include:
- Channeling remittances into investment.
- Strengthening financial institutions.
- Promoting growth sectors such as tourism.
- Digitalization initiatives (notably a national digital ID system).
- Improving education, training, and immigration policies to offset emigration’s toll on labor and skills.
- Easing regulatory hurdles and attracting FDI to boost investment and job creation.
Disaster resilience and regional initiatives
- Enhancing resilience to natural disasters is a top priority.
- Support for the Pacific Resilience Facility (PRF) through a Treaty-based agreement endorsed by Pacific Island Forum Members consolidates financing through a Pacific-owned mechanism and ensures predictable, regionally governed access to funding that reaches vulnerable communities directly.
Governance and anti-corruption
- Address systemic weaknesses in governance frameworks, regulatory capacity, and the AML/CFT regime.
- Build institutional capacity to strengthen transparency, safeguard public resources, and mitigate vulnerabilities to corruption.
- The 2024 establishment of Tonga’s first Anti-Corruption Commission Office is highlighted as an important step.

Acknowledgment
- The IMF mission team thanks the Ministry of Finance, the National Reserve Bank of Tonga, other ministries and government agencies, and private sector interlocutors for their hospitality and constructive discussions and looks forward to maintaining constructive engagement and policy dialogue.

Source: Tonga: Staff Concluding Statement of the 2025 Article IV Mission (August 25, 2025).