Press Release No. 15/180

Press Release: IMF Executive Board Concludes 2015 Article IV Consultation with Tonga

April 27, 2015

The Executive Board of the International Monetary Fund (IMF) has concluded the Article IV consultation¹ with Tonga and considered and endorsed the staff appraisal without a meeting on April 24, on a lapse-of-time basis.²

Tonga’s economy is estimated to have grown by around 2 percent in fiscal year (FY) 2013/14 (year ending June), driven by agriculture and construction, following a contraction in 2012/13 mainly caused by the completion of a large capital project. Inflation has remained moderate at around 0-3 percent in recent years, reflecting low global food prices and, more recently, a sharp decline in oil prices. The external position has strengthened, following large grants and remittance inflows, which have bolstered international reserves.

Real GDP growth is expected to average 2–3 percent in FY2014/15–FY2019/20. Although the progress of reconstruction in the aftermath of 2014 Cyclone Ian is slower than expected, the coronation scheduled for July 2015 and preparations for the 2019 South Pacific Games will support economic activity over the next few years. Meanwhile, inflation is projected to remain low, reflecting the weak outlook for global commodity prices.

The balance of risks remains weighted to the downside. Spillovers from a protracted period of slower growth in advanced and emerging economies could weigh on Tonga, mainly due to its close economic ties with Australia and New Zealand. On the domestic side, potential cost overruns relating to the Pacific Games could make it necessary to mobilize additional fiscal resources.

Executive Board Assessment

In concluding the 2015 Article IV consultation with Tonga, Executive Directors endorsed staff’s appraisal, as follows:

Tonga’s economy has rebounded and the outlook is favorable, while risks remain tilted to the downside. Growth is recovering and is expected to average 2–3 percent during the next five years, mainly supported by construction and tourism on the back of several large events (the coronation and the Pacific Games). Inflation is projected to remain low, reflecting the weak outlook for global commodity prices. International reserves are expected to stay comfortable at around 6 months of prospective imports largely, thanks to grants and remittances. The balance of risks is tilted to the downside. External risks involve spillovers from a protracted period of slower growth in advanced and emerging economies, which could weigh on Tonga, mainly through its close economic ties with Australia and New Zealand. On the domestic side, potential cost overruns related to the Pacific Games continue to pose downside risks.

The authorities should contain fiscal spending pressures in the near-term and build a sound fiscal position to bolster resilience to shocks over the medium term. Near-term fiscal pressures stem mostly from potentially large wage increases for civil servants, which can be contained by more efficient staff allocation in order to moderate the share of the wage bill in recurrent spending over the medium term. Controlling the spending program for the Pacific Games is also important to avoid cost overruns. The adoption of a roadmap for public financial management reform and the debt management strategy would lay the groundwork for a medium-term fiscal framework. Continued efforts to increase tax revenue by broadening the tax base and strengthening tax administration could create more room for priority social spending and public investment.

The current accommodative monetary policy stance is appropriate in view of the weak economy and low inflation, while large excess liquidity calls for better liquidity management to mitigate macro-financial risk. Preserving the current level of international reserves would help ensure external stability, and lowering the inflation reference rate would better anchor inflation expectations over the medium term. Although the presence of excess liquidity does not pose an imminent risk to financial sector soundness in the near term, the authorities should prepare to manage macro-financial risks by improving liquidity management and adopting macro-prudential tools. The progress in improving banks’ balance sheets and strengthening the legal framework in the financial sector is welcome.

Structural reforms remain imperative to raising Tonga’s potential growth. Progress in updating Tonga’s strategic development framework (TSDF II) is welcome. Steadfast implementation of the authorities’ reform plan is crucial to make growth more sustainable and inclusive. Implementing key initiatives, such as revising the Foreign Investment Act, would help improve the business climate and promote private sector development.

Implementing TA recommendations are important for successful reforms. Improving the quality of data statistics will also help policy formulation and facilitate private sector decisions. In view of limited resources, better coordination and prioritization of Tonga’s prospective TA program is needed. The IMF/Pacific Financial Technical Assistance Center (PFTAC) would continue to provide the bulk of technical assistance, in coordination with other development partners.