## Tonga: Staff Concluding Statement of the 2023 Article IV Mission

_IMF News, August 7, 2023_

## Source details

**Canonical URL:** [Tonga: Staff Concluding Statement of the 2023 Article IV Mission](https://www.imf.org/en/news/articles/2023/08/04/tonga-staff-concluding-statement-of-the-2023-article-iv-mission)

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## Bibliographic details
- Published: August 7, 2023

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### 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.*

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## References

- [Tonga and the IMF](http://www.imf.org/external/country/TON/index.htm)
- [IMF Policy Advice -- A Factsheet](https://www.imf.org/en/about/factsheets/imf-surveillance)
- [Mission Concluding Statements](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [IMF-World Bank 2021 Climate Change Policy Assessment Report](https://www.imf.org/en/Publications/CR/Issues/2020/06/30/Tonga-Technical-Assistance-Report-Climate-Change-Policy-Assessment-49537)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2023/08/04/tonga-staff-concluding-statement-of-the-2023-article-iv-mission_