Tonga: Staff Concluding Statement IMF 2020 Article IV Consultation Mission
IMF News, February 25, 2020
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- Published: February 25, 2020
Overview
- A mild recovery is underway after Cyclone Gita, driven by stronger consumption supported by remittances and donor-funded reconstruction boosting imports.
- Policies have delivered low inflation, a fourth consecutive budget surplus, and financial sector stability.
- The medium-term outlook is modest and fragile due to slower growth in remitting/partner countries, high vulnerability to natural disasters, and high debt distress with repayments set to spike from 2024 onward.
- Main challenge: improve climate resilience and meet development goals without worsening debt dynamics by strengthening budget surpluses, improving revenue and spending quality, expediting investment, and securing large additional donor grant funding.
- Durable long-term solution: grow the private sector; improving the operation of the land market is crucial.
Economic performance and outlook
- Recent performance
- Growth: estimated at 3 percent in FY2019, recovering from FY2018 stagnation due to Cyclone Gita.
- Drivers: stronger consumption from remittances, accommodative monetary policy, and credit growth.
- Headwinds: loss in market share for agricultural exports and slower growth in partner/remitting countries.
- Inflation: low, driven by weaker global commodity prices and dissipation of post-Gita local price surge.
- International reserves: US$214 million at end-2019 (equal to some 6½ months of import cover).
- Outlook and projections
- Short term: recovery expected to speed up in 2020-21 to 3½ percent GDP growth as exports and investment recover.
- Medium term: growth expected to gradually decline to an estimated potential rate of 1.8 percent.
- Inflation: likely to remain well below the reference rate of 5 percent.
- External balances: expected to deteriorate; reserve coverage to trend down to about 4 months of imports (below desirable 6¾ months).
Risks and vulnerabilities
- Debt and financing
- High risk of external debt distress because of an impending spike in debt repayments starting in 2024, particularly to the Exim Bank of China.
- Without new grant financing and additional fiscal adjustment, reserves will need to be run down and additional debt incurred.
- Natural disasters and climate
- Tonga is among the world’s most exposed to climate change and natural disasters; another major cyclone could derail recovery and strain public resources.
- IMF CCPA estimates climate-resilience projects will cost some 140 percent of 2018 GDP, of which donor funding has been committed for about half.
- Global factors
- Rising protectionism, weaker global growth, and knock-on effects of the coronavirus may temper exports, tourism, aid and remittances.
- Institutional and capacity constraints
- Limited public sector capacity to prepare for and manage risks; need for stronger AML/CFT framework to reduce vulnerability to correspondent banking relationship withdrawals.
Priority #1 — Achieving climate resilience and development goals while ensuring debt sustainability
- Financing needs and targets
- Climate-resilience projects: some 140 percent of 2018 GDP (donor funding committed for about half).
- Additional annual spending to meet development goals by 2030: 5 percent of 2018 GDP by 2030.
- National Emergency Fund target: around 1 percent of GDP.
- Public debt target: 35 percent of GDP to ensure stable long-term debt dynamics.
- Without new grants, required annual fiscal surpluses: some 4 percent of GDP on average over 2021−24 (vs. draft FY2021 surplus target of 0.8 percent of GDP).
- Revenue measures (higher-quality consolidation)
- Review and close major consumption tax exemptions.
- Update excise tax rates, fees and charges, especially on property.
- Improve revenue administration through training and better risk management.
- Remove tax breaks for the electricity company and pass through full diesel generation costs to consumers (with phased protection for vulnerable households).
- Consider broadening the personal income tax base; close corporate income tax loopholes for multi-national companies; collect tax arrears; reduce tax avoidance; improve collection of land-related fees.
- Institutionalize management of resources set aside for debt repayments via legislation.
- Spending measures (efficiency and capacity)
- Gear current spending toward capacity and value-for-money; address rising non-salary wage components.
- Strengthen expenditure controls on allowances and non-permanent staff costs.
- Conduct a systemic review to determine appropriate and fiscally sustainable public service size and structure.
- Centralize and strengthen hiring/staffing decisions; clarify job descriptions; prioritize critical positions; increase automation to phase out redundant positions.
- Carefully design planned health insurance and voluntary retirement schemes to avoid cost overruns and large staff turnover.
- Prioritize and publish investment pipeline; strengthen procurement and bundle contracts to attract international firms.
- Debt management
- Continue borrowing on concessional terms and limiting external debt-to-GDP ratio below 50 percent; financing should ideally be restricted to grants if possible.
- Adopt a medium-term debt strategy with documentation of policies and procedures to guide borrowing and guarantees.
- Explore scope to expand domestic borrowing to limit foreign currency risk and improve monetary transmission.
- Role of donor financing and private sector
- Large additional donor financing in grants will be essential to avoid worsening debt dynamics.
- Even with grants, capacity constraints limit ramping up spending; growing the private sector to expand the tax base is vital.
Priority #2 — Unlocking private sector potential
- Key constraints and reform priorities
- Main priorities: improve access to skilled labor, land, infrastructure, credit, and technology; ease entry barriers by strengthening official capacity and female labor force participation; reduce investment uncertainty by improving climate resilience, insolvency regimes and aligning the 2018 FEC Act with international norms.
- Amendments to the 2018 FEC Act are under consideration to improve repatriation requirements while ensuring investor certainty.
- Land market (priority action)
- Leasehold market complexity, non-transparency and delays hinder Tongan and foreign investment.
- Legal tenures allow up to 50 years (Cabinet approval) or 99 years (Privy Council approval), but in practice tenures are much shorter (10−30 years) with unregulated renewal processes.
- Selling Tongan land is illegal; informal transactions function via “gifts” in exchange for land.
- Low liquidity and short tenures impede use of real estate as collateral for MSMEs and limit banks’ ability to finance long-term investments (e.g., private solar farms).
- Recommended: modernize and clarify land lease process; improve transparency and predictability; clarify ownership rights to maximize use of underutilized land and improve incentives for climate-resilient structures.
- Female labor force participation
- Female workforce has more years of schooling but is constrained by limits to land ownership, inadequate legal protections (especially property rights), and poor government representation.
- Government plan to improve female participation is under-resourced and ill-defined.
- Employment Relations Bill (approved by Cabinet) could improve employment conditions for women once enacted.
- Business formation and insolvency
- Improve insolvency regime for predictable, speedy, transparent resolution and better protection of secured creditors’ rights.
- Facilitate in and out-of-court solutions, develop non-bank financial institutions, reform land leasehold market, improve credit bureau functioning, enhance financial training and literacy for MSMEs.
- Deregulate restricted lists of protected sectors to allow greater foreign investment.
Other policy recommendations
- Monetary policy
- Maintain supportive stance given low inflation.
- Raising statutory reserve requirement from 10 to 15 percent of deposits is acceptable given excess liquidity, to allow greater room for easing if conditions worsen.
- NRBT should look through temporary inflation spikes and stand ready to raise interest rates on excess reserves if overheating or credit misallocation emerge.
- Financial sector supervision
- Continue improvements: establish solvency stress testing, assess climate and remittance-related stress impacts, enhance financial sector risk management, and improve insolvency regimes.
- Monitor household debt closely given signs of stretched household balance sheets and large bank exposure to household mortgages.
- AML/CFT
- Strengthen AML/CFT framework to meet international standards and address concerns likely to arise in the 2020 APG assessment to reduce risks of partial withdrawal of correspondent banking relationships.
Key statistics (selected)
- Population (2018): 101 thousand
- Quota: SDR 13.8 million
- Real GDP growth (annual percent change)
- FY2017: 5.4
- FY2018: 0.2
- FY2019: 3.0
- FY2020: 3.5 (projection)
- FY2021: 2.6 (projection)
- FY2022: 2.3 (projection)
- Consumer prices (period average)
- FY2017: 7.2
- FY2018: 7.0
- FY2019: 4.1
- FY2020: 1.3 (projection)
- FY2021: 2.2 (projection)
- FY2022: 1.2 (projection)
- Consumer prices (end of period)
- FY2017: 9.8
- FY2018: 6.7
- FY2019: 1.6
- FY2020: 1.7 (projection)
- FY2021: -0.4 (projection)
- FY2022: 3.2 (projection)
- Central government finance (percent of GDP)
- Revenue and Grants
- FY2017: 43.6
- FY2018: 42.9
- FY2019: 44.2
- FY2020: 40.5 (projection)
- FY2021: 39.5 (projection)
- FY2022: 39.1 (projection)
- FY2023: 35.3 (projection)
- Revenue (excluding grants)
- FY2017: 24.2
- FY2018: 25.0
- FY2019: 28.2
- FY2020: 23.8 (projection)
- FY2021: 24.0 (projection)
- Grants
- FY2017: 19.5
- FY2018: 17.9
- FY2019: 16.0
- FY2020: 16.7 (projection)
- FY2021: 15.7 (projection)
- FY2022: 15.1 (projection)
- FY2023: 11.1 (projection)
- Expenditure
- FY2017: 40.0
- FY2018: 41.5
- FY2019: 39.2
- FY2020: 38.8 (projection)
- FY2021: 38.2 (projection)
- Expense
- FY2017: 29.6
- FY2018: 31.6
- FY2019: 32.5
- FY2020: 31.1 (projection)
- FY2021: 30.9 (projection)
- FY2022: 30.6 (projection)
- Transactions in nonfinancial assets (net)
- FY2017: 10.4
- FY2018: 8.4
- FY2019: 9.0
- FY2020: 9.4 (projection)
- FY2021: 8.3 (projection)
- FY2022: 8.2 (projection)
- FY2023: 7.6 (projection)
- Overall balance
- FY2017: 3.6
- FY2018: 2.9
- FY2019: 2.7
- FY2020: 0.0 (projection)
- FY2021: 0.3 (projection)
- FY2022: -2.9 (projection)
- Public debt (external and domestic)
- FY2017: 46.0
- FY2018: 45.6
- FY2019: 41.6
- FY2020: 39.7 (projection)
- FY2021: 37.7 (projection)
- FY2022: 36.0 (projection)
- FY2023: 38.7 (projection)
- External debt
- FY2017: 34.1
- FY2018: 30.7
- FY2019: 27.6
- FY2020: 28.0 (projection)
- Debt service ratio
- FY2017: 1.1
- FY2018: 1.9
- FY2019: 1.8
- Total liquidity (M3) annual change
- FY2017: 13.7
- FY2018: 4.3
- FY2019: 5.6
- FY2020: 5.7 (projection)
- FY2021: 4.2 (projection)
- Domestic credit
- FY2017: 4.8
- FY2018: -6.5
- FY2019: 6.0
- FY2020: 28.1 (projection)
- FY2021: 18.0 (projection)
- FY2022: 15.6 (projection)
- FY2023: 10.6 (projection)
- Exports, f.o.b. (annual percent change)
- FY2017: 4.6
- FY2018: 5.0
- Imports, f.o.b. (annual percent change)
- FY2017: -45.2
- FY2018: -44.9
- FY2019: -49.9
- FY2020: -52.5 (projection)
- FY2021: -52.9 (projection)
- FY2022: -53.6 (projection)
- FY2023: -54.1 (projection)
- Services (net)
- FY2017: -3.4
- FY2018: -3.1
- FY2019: -5.5
- FY2020: -5.9 (projection)
- FY2021: -6.1 (projection)
- FY2022: -7.0 (projection)
- FY2023: -6.8 (projection)
- Current transfers (net)
- FY2017: 33.6
- FY2018: 33.0
- FY2019: 35.0
- FY2020: 34.4 (projection)
- FY2021: 33.3 (projection)
- FY2022: 30.4 (projection)
- Of which: Remittances
- FY2017: 27.4
- FY2018: 29.4
- FY2019: 30.0
- FY2020: 28.5 (projection)
- FY2021: 29.5 (projection)
- FY2022: 27.8 (projection)
- Of which: Official grants
- FY2017: 7.8
- FY2018: 5.2
- Current account balance
- FY2017: -11.8
- FY2018: -12.6
- FY2019: -15.2
- FY2020: -18.1 (projection)
- FY2021: 4.7 (projection)
- FY2022: -1.3 (projection)
- FY2023: -4.4 (projection)
- Gross official foreign reserves (millions of U.S. dollars)
- FY2017: 192.2
- FY2018: 214.9
- FY2019: 212.8
- FY2020: 212.3 (projection)
- FY2021: 205.2 (projection)
- FY2022: 179.5 (projection)
- FY2023: 158.3 (projection)
- Memorandum: Nominal GDP (millions of US$)
- FY2017: 455.9
- FY2018: 481.9
- FY2019: 503.8
- FY2020: 529.4 (projection)
- FY2021: 560.4 (projection)
- FY2022: 588.6 (projection)
- FY2023: 619.6 (projection)
IMF Staff Concluding Statement, Tonga: Staff Concluding Statement IMF 2020 Article IV Consultation Mission (February 25, 2020).