Tonga: Staff Concluding Statement of the 2023 Article IV Mission
IMF News, August 7, 2023
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- Published: August 7, 2023
Key findings and recent developments
- The Tongan economy is rebounding strongly from a major double shock in early 2022.
- Real GDP:
- FY2022: contraction of 2 percent (estimated).
- FY2023 (July 2022-June 2023): expansion of 2.6 percent (estimated).
- Recovery drivers in FY2023:
- Bold policy support measures in response to the Hunga Tonga‒Hunga Ha’apai (HTHH) volcanic eruption-tsunami and the local COVID-19 outbreak.
- Aid from the international community.
- Strong domestic demand and a pickup in tourist arrivals after border reopening in August 2022.
- Inflation and supply constraints:
- Headline inflation peaked at 14.1 percent in September 2022 and moderated to 6.6 percent in May 2023.
- Core inflation showed no signs of easing since September 2022.
- Labor shortages due to seasonal worker programs in Australia and New Zealand and slow rebuilding of damaged tourism facilities.
- Credit developments:
- Bank credit growth positive since September 2022, reaching 5.9 percent (y/y) in May 2023.
- Bank lending to businesses: 12.5 percent (y/y) in May 2023.
- Household lending: 1.2 percent (y/y) in May 2023, with around 80 percent towards housing.
- Government Development Loan (GDL) scheme provided subsidized interest rate loans to small businesses and low-income households.
Outlook and risks
- Short-term outlook:
- Growth FY2024 projected at 2.5 percent, underpinned by public investment.
- Tourism receipts as share of GDP expected to remain below pre-pandemic levels until FY2026 due to slow reconstruction of damaged facilities.
- Remittances projected to decline from 44.2 percent of GDP in FY2023 to 39.7 percent in FY2024.
- Average inflation projected at 5.8 percent in FY2024—above the NRBT’s reference rate of 5 percent.
- Medium-to-long-term prospects:
- Long-term growth projected at 1.2 percent.
- FX reserve coverage projected to stabilize at about 11 months of imports, above the NRBT’s target of 7½ months, supported by external financing.
- Risk assessment:
- Risks tilted to the downside: limited productive capacity, strong foreign demand for workers, potential sharp increase in global commodity prices, frequent natural disasters, and loss of correspondent banking relationships (CBRs) affecting remittances.
- Upside risk: faster-than-expected recovery in tourism.
- Debt distress assessment:
- Tonga assessed as being at high risk of debt distress.
- Without additional grant commitments to IMF staff’s baseline projection, PV of public debt-to-GDP projected to rise and remain above the 70 percent debt-distress benchmark starting in FY2033.
- Debt obligations largely external, with over half to China Exim Bank.
- Debt repayments expected to surge in FY2024 and stay elevated at over 3 percent of GDP until FY2027.
External position
- Current account:
- CAD widened from 6.3 percent of GDP in FY2022 to 7.9 percent in FY2023 (estimated).
- Reserves and external support:
- FX reserves increased in FY2023; import cover strengthened to about 11 months.
- Supported by official capital transfers and the IMF’s Rapid Credit Facility (RCF) disbursement in July 2022.
Fiscal policy recommendations and assessment
- Recent fiscal performance:
- Primary deficit declined from 0.6 percent of GDP in FY2021 to 0.2 percent in FY2022.
- Primary fiscal balance expected to shift to a surplus of 1.0 percent in FY2023 (driven by HTHH-related external grants more than offsetting reconstruction expenditures).
- FY2024 budget and near-term stance:
- Expanded budget envelope for FY2024 appropriate to support reconstruction and strengthen social protection.
- Primary balance expected to revert to a deficit of 6.3 percent of GDP in FY2024 as HTHH-related grants unwind and reconstruction spending ramps up.
- Authorities have phased out most pandemic- and HTHH-related tax exemptions and plan gradual normalization of current spending, including limiting the public sector wage bill.
- Government plans to top-up the GDL fund to help vulnerable households access credit.
- Medium-term fiscal needs and policy recommendations:
- Combination of domestic fiscal measures and additional donor support required to meet development spending needs while minimizing debt distress risk.
- Suggested fiscal adjustments:
- Gradual increases in tax revenues.
- Further reductions in the public wage bill and other current expenditures.
- Refrain from new non-concessional borrowing (government’s plan).
- Critical to secure new grants in line with historical trends to fund capital investment projects.
- Public financial management and revenue administration reforms:
- Continue rollout of the Electronic Sales Register System to improve revenue compliance.
- Amendments to the PFM Act to improve fiscal transparency and medium-term budgeting.
- Reduce tax exemptions and strengthen governance for granting exemptions (clear eligibility criteria, limited timeframes, Minister of Finance authority).
- Publish pandemic-related procurement contracts with information on beneficial ownership as committed under IMF’s RCF.
Monetary and exchange rate policy recommendations
- NRBT recent actions:
- Increased statutory reserve deposit (SRD) ratio from 10 to 15 percent in February 2023.
- Maintained the policy rate (rate on excess bank reserves) at zero percent.
- Established a deposit facility for retirement funds in February 2023.
- These measures helped absorb banking system liquidity but have yet to meaningfully impact aggregate demand.
- Policy needs to contain inflation:
- Under staff’s baseline with current settings, inflation would remain above the reference rate until end-FY2024.
- Recommendation: further tighten monetary policy to prevent high inflation expectations from becoming entrenched.
- Specific options:
- Increase the policy rate from the current zero percent level.
- Possibly combine with a further hike in the SRD ratio to mop up liquidity.
- Rationale: raising the policy rate now creates room to lower it if downside risks materialize (e.g., a major natural disaster).
- Framework enhancements:
- Consider resuming issuance of NRBT notes (suspended since 2009) to provide a market-based instrument to absorb excess liquidity.
- Clarify operational guidelines for transfer of profits, coverage of losses, and recapitalization to avoid concerns about NRBT’s operational independence if sterilization costs rise.
Financial sector policies and recommendations
- Systemic soundness:
- System-wide capital adequacy ratio around 35 percent in 2023Q1 (regulatory requirement 15 percent).
- Excess reserves at 30.2 percent of GDP as of April 2023.
- Banks remain profitable, though average return on assets below pre-pandemic levels as of end-FY2022.
- Asset quality:
- NPL ratio increased from 3.6 percent at end-2021 to 7.4 percent in 2023Q1.
- Business NPLs rose faster (distribution and construction leading); household NPL share declined, with housing loans accounting for over 75 percent of household NPLs.
- NPL coverage ratio declined from 141.3 percent at end-2021 to 99.3 percent in 2023Q1.
- Capacity to withstand another severe near-term shock likely weakened.
- Recommended supervisory and regulatory actions:
- More intrusive oversight for banks with higher NPLs (frequent/detailed reporting, intensified on-site supervision, possible dividend restrictions).
- Require more conservative provisioning, including for secured loans (at least partly) and overdue non-NPL loans.
- Request bank NPL resolution plans with concrete operational targets (e.g., reduce NPLs to a target level over a specified time window; maintain provisioning above a minimum threshold).
- Streamline prudential standards and enhance data collection with IMF TA support.
- Broaden NRBT’s regulatory and supervisory remit to cover non-bank financial institutions (NBFIs).
- Financial deepening and inclusion:
- Support NRBT initiative to set up a local credit registry and expand it to include NBFIs.
- Strengthen financial literacy through financial education in schools and community engagement.
Structural reforms and capacity building
- Disaster resilience and climate change:
- Top reform priority: enhance resilience to natural disasters and climate change.
- Disaster Risk Management Act of 2023 shifts focus from ex-post responses to ex-ante risk mitigation and preparedness.
- Priorities: expand classification of climate change-related spending, strengthen social protection, enforce Building Code (especially for residential properties), facilitate relocation to safer grounds, allocate adequate fiscal resources.
- Private sector development and human capital:
- Digitalization and national digital ID system are key to overcoming geographic barriers and improving public service delivery.
- Reinforce digital ID with government-wide move away from paper-based processes and investment in ICT and internet coverage.
- Other priorities:
- Increase government spending on education and training to reduce skill mismatch.
- Reduce gender inequality in the labor market; enact the Employment Relations Bill to better protect women.
- Cut red tape hindering private investment; improve efficiency of land leasehold administration (e.g., necessary IT systems).
- Strengthen AML/CFT framework; address gaps identified by Asia Pacific Group on Money Laundering (APG) in the Mutual Evaluation Report, including amendments to the AML Act.
- Statistics and capacity constraints:
- Severe capacity constraints in producing timely macroeconomic statistics.
- Delays in publishing core macroeconomic data (national accounts, external sector statistics) have become more prolonged and frequent.
- Need stricter enforcement of current law on data sharing and cooperation across ministries.
- IMF provided extensive TA in national accounts, government finance, and balance of payments.
Key statistics (selected)
- Population (2021): 100 thousands
- Major exports: root crops, vanilla, squash, fish
Table 1 (selected indicators, est. and projections)
- Real GDP growth:
- FY2021: -2.7
- FY2022: -2.0
- FY2023: 2.6
- FY2024: 2.5
- FY2025: 2.2
- Consumer prices (period average):
- FY2021: 1.4
- FY2022: 8.5
- FY2023: 10.0
- FY2024: 5.8
- FY2025: 4.1
- Consumer prices (end of period):
- FY2021: 6.9
- FY2022: 11.3
- FY2023: 6.1
- FY2024: 6.2
- FY2025: 3.2
- Central government finance (percent of GDP):
- Revenue: FY2021 48.3; FY2022 45.2; FY2023 47.7; FY2024 41.6; FY2025 37.6
- Grants (of revenue): FY2021 22.4; FY2022 19.0; FY2023 24.4; FY2024 17.0; FY2025 12.9
- Expenditure: FY2021 49.3; FY2022 45.9; FY2023 47.4; FY2024 46.1; FY2025 …
- Expense: FY2021 41.8; FY2022 40.1; FY2023 37.3; FY2024 35.1
- Net acquisition of nonfinancial assets: FY2021 7.5; FY2022 5.9; FY2023 7.2; FY2024 11.0; FY2025 …
- Primary balance: FY2021 -0.6; FY2022 -0.2; FY2023 1.0; FY2024 -6.3; FY2025 -8.0
- Overall balance: FY2021 -1.0; FY2022 -0.7; FY2023 0.4; FY2024 -6.8; FY2025 -8.5
- Overall balance (excl. grants): FY2021 -23.4; FY2022 -19.7; FY2023 -24.0; FY2024 -23.8; FY2025 -21.4
- Money and credit (annual percent change):
- Broad money (M2): FY2021 25.0; FY2022 13.4; FY2023 -0.1; FY2024 4.5; FY2025 3.4
- Domestic credit: FY2021 -8.2; FY2022 -3.3; FY2023 3.9; FY2024 16.1; FY2025 8.8
- Balance of payments (millions of U.S. dollars):
- Current account balance: FY2021 -24.7; FY2022 -31.5; FY2023 -43.1; FY2024 -41.1; FY2025 -45.1
- Exports of goods, f.o.b.: FY2021 16.2; FY2022 15.1; FY2023 16.3; FY2024 18.4; FY2025 19.6
- Imports of goods, f.o.b.: FY2021 214.5; FY2022 214.9; FY2023 295.7; FY2024 285.7; FY2025 295.4
- Tourism receipts: FY2021 9.1; FY2022 9.6; FY2023 35.6; FY2024 50.9; FY2025 58.5
- Total remittances: FY2021 220.6; FY2022 218.5; FY2023 242.1; FY2024 230.9; FY2025 227.9
- Remittances (percent of GDP):
- Est./Proj: FY2021 46.9; FY2022 43.9; FY2023 44.2; FY2024 39.7; FY2025 37.5
- Compensation of overseas workers: FY2021 41.0; FY2022 37.9; FY2023 47.1; FY2024 51.9; FY2025 56.9
- Personal remittances: FY2021 179.6; FY2022 180.6; FY2023 195.0; FY2024 179.0; FY2025 171.0
- Official grants: FY2021 10.5; FY2022 26.4; FY2023 85.4; FY2024 75.1; FY2025 78.4
- Capital account balance: FY2021 69.1; FY2022 84.6; FY2023 53.1; FY2024 29.0; FY2025 5.4
- Financial account balance: FY2021 1.1; FY2022 23.7; FY2023 -6.6; FY2024 25.3
- Gross official foreign reserves (millions of U.S. dollars): FY2021 317.9; FY2022 375.5; FY2023 388.1; FY2024 401.4; FY2025 409.1
- Reserves (months of next year's total imports): FY2021 11.7; FY2022 10.3; FY2023 10.9; FY2024 10.8; FY2025 …
- Debt and external indicators:
- Public debt (external and domestic): FY2021 47.8; FY2022 45.4; FY2023 41.2; FY2024 51.6
- Of which: External debt: FY2021 39.4; FY2022 37.2; FY2023 38.0
- External debt service ratio: FY2021 0.7; FY2022 1.5; FY2023 2.1; FY2024 3.8; FY2025 3.5
- Nominal GDP (millions of US$): FY2021 470.5; FY2022 497.6; FY2023 547.2; FY2024 581.1; FY2025 607.5
- Real effective exchange rate (2010=100; +=appreciation): FY2021 107.1; FY2022 115.7
Source: IMF staff concluding statement of the 2023 Article IV mission for Tonga.