Washington, DC: On January 25, 2021, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Tonga.
Tonga’s slow recovery from the devastating 2018 Tropical Cyclone Gita has been derailed by twin shocks from the Covid-19 pandemic and Cyclone Harold. Proactive and timely actions, including the early closure of external borders and prompt economic support, have helped avoid a worse economic outcome and there are no recorded COVID-19 cases in Tonga to date. Nevertheless, FY2020 GDP (ending June 2020) is expected to contract by 2½ percent, followed by a further contraction of 3½ percent in FY2021, as Tonga’s peak tourism season gets underway while borders remain closed and reconstruction efforts continue to be delayed. The latter has led to record high international reserves as delayed aid-spending resulted in import compression. Nevertheless, external balances are expected to deteriorate, as declines in tourism and remittance inflows, and higher pandemic- and reconstruction-related imports are expected to worsen the current account deficit, sharply reducing reserves in FY2021. Notwithstanding the pandemic, fiscal consolidation continued through FY2020 as a result of donor support and investment delays. However, a fiscal deficit is unavoidable in FY2021 given the need to support the economy and healthcare through the pandemic. Given limited fiscal buffers and urgent balance of payments needs, Tonga has requested IMF financial assistance under the Rapid Credit Facility. While monetary stability has been maintained and inflation is expected to remain low, financial sector risks are elevated even though banks are still profitable and well capitalized.
The medium-term outlook is modest and fragile. Tonga’s growth potential is low due to its heavy reliance on labor exports, and the pandemic has worsened pre-existing vulnerabilities. A weaker global recovery that weighs on exports, aid, and remittances, and further disruptions in correspondent banking relations pose significant downside risks, as does the possibility of a local outbreak. Tonga is highly vulnerable to natural disasters and is at a high risk of external debt distress. Large external debt repayments come due starting in 2024, while current account deficits are also likely to remain large, reflecting persistently weak export competitiveness and heavy import dependence, a pickup in reconstruction and the implementation of delayed climate-resilient infrastructure investments. Together, these forces are likely to reduce international reserves below desirable levels in the medium-term.
Executive Board Assessment [2]
Executive Directors commended the authorities for their swift actions to prevent a local outbreak of the pandemic, and for prudent policy management, which has preserved macro-financial stability. Directors noted that the global pandemic and recent natural disasters have amplified the already weak economic growth, worsened fiscal and external balances, and added pressure on debt sustainability. The medium-term outlook remains fragile, with low growth potential and sizable financing needs. Given Tonga’s high risk of debt distress, Directors underscored the importance of post-pandemic fiscal adjustment and continued financial support from the international community, including through grants and debt relief, as well as technical assistance from the Fund.
Directors agreed that fiscal policy should continue to support the economy through the pandemic, while improving the targeting of measures and safeguarding priority spending on an effective vaccine rollout, healthcare, infrastructure maintenance, and investment. They emphasized that, once the recovery is underway, high-quality fiscal adjustment will be needed to stabilize debt dynamics and strengthen climate resilience. They recommended broadening the tax base, enhancing spending efficiency, and expanding the social protection system. Directors also encouraged the authorities to improve public financial management, debt management strategies, and transparency and governance in government operations.
Directors welcomed the continued monetary policy support, given low inflation. They noted that, while banks are still profitable and well-capitalized, financial sector risks are rising, given the prospects for deteriorating credit quality and the withdrawal of correspondent banking relationships. This calls for stronger financial sector supervision, including by strengthening stress testing and the monitoring of household debt. Directors also encouraged establishing a macroprudential framework and enhancing the AML/CFT framework.
Directors stressed the need to promote private sector growth through structural reforms, prioritizing measures to enhance the business environment, climate resilience, and productivity. In this regard, they encouraged improving land market operations, strengthening female labor force participation, enacting an insolvency law, and deregulating protected sectors.
Table 1. Tonga: Selected Economic Indicators, FY2018 -FY20231 | ||||||
Population (2019): 104 thousands | ||||||
GDP per capita FY2018 (thousands of US$): 4.9 | ||||||
Key export markets: Australia, Japan, New Zealand, and United States | ||||||
Major exports: root crops, vanilla, squash, fish | ||||||
Quota: SDR 13.8 million | ||||||
Est. | Projections | |||||
FY2018 | FY2019 | FY2020 | FY2021 | FY2022 | FY2023 | |
Output and prices | (Annual percent change) | |||||
Real GDP2 | 0.3 | 0.7 | -2.5 | -3.5 | 4.0 | 3.0 |
Consumer prices (period average)3 | 6.8 | 3.3 | 0.2 | -0.9 | 2.1 | 2.0 |
Consumer prices (end of period)3 | 6.7 | -0.1 | -1.4 | 1.8 | 2.4 | 1.6 |
GDP deflator | 5.1 | 7.7 | 0.4 | -0.9 | 2.1 | 2.0 |
Central government finance | (In percent of GDP) | |||||
Total Revenue | 42.6 | 41.7 | 45.7 | 45.7 | 42.0 | 44.4 |
Revenue (excluding grants) | 24.8 | 23.4 | 24.7 | 22.9 | 23.9 | 24.3 |
Grants | 17.8 | 18.3 | 21.0 | 22.9 | 18.1 | 20.1 |
Total Expenditure | 39.7 | 38.5 | 41.3 | 50.6 | 42.3 | 43.4 |
Expense | 31.4 | 30.3 | 35.4 | 44.4 | 35.6 | 34.9 |
Transactions in Nonfinancial Assets (Net) | 8.3 | 8.3 | 5.9 | 6.2 | 6.7 | 8.5 |
Overall balance | 2.9 | 3.2 | 4.4 | -4.8 | -0.3 | 1.0 |
Net Acquisition of Financial Assets | 2.4 | 2.0 | 5.1 | -1.8 | 0.5 | 1.3 |
External financing (net) | -0.6 | -1.2 | -0.5 | 1.6 | -1.4 | -1.7 |
Domestic financing (net) | 0.1 | 0.0 | 1.1 | 1.4 | 2.2 | 2.0 |
Money and credit | (Annual percent change) | |||||
Total liquidity (M3) | 7.6 | 4.3 | 1.2 | -8.9 | 10.6 | 7.7 |
Of which: Broad money (M2) | 9.4 | 3.5 | 1.1 | -9.4 | 11.1 | 8.0 |
Domestic credit | -6.5 | 6.0 | -15.7 | 4.0 | 18.4 | 12.0 |
Of which: Private sector credit | 6.7 | 7.6 | 1.1 | 0.7 | 3.4 | 3.9 |
Interest rates (end of period) | ||||||
Average deposit rate | 2.3 | 2.3 | 2.3 | … | … | … |
Average lending rate | 8.5 | 8.2 | 8.1 | … | … | … |
Balance of payments | (In millions of U.S. dollars) | |||||
Exports, f.o.b. | 14.2 | 15.8 | 18.3 | 14.4 | 17.7 | 19.0 |
Imports, f.o.b. | 215.3 | 223.3 | 213.7 | 208.2 | 234.6 | 246.7 |
Services balance | -15.0 | -9.3 | -20.9 | -88.2 | -29.7 | -36.3 |
Investment income balance | 26.4 | 39.9 | 42.2 | 14.7 | 27.4 | 34.6 |
Transfers balance | 158.9 | 172.4 | 154.4 | 181.3 | 168.7 | 182.6 |
Of which: Remittances | 137.1 | 141.6 | 144.9 | 113.8 | 122.4 | 128.0 |
Of which: Official grants | 28.8 | 45.3 | 20.3 | 84.3 | 64.2 | 73.4 |
Current account balance | -30.7 | -4.4 | -19.6 | -85.9 | -50.5 | -46.9 |
(In percent of GDP) | -6.3 | -0.9 | -3.9 | -17.5 | -9.6 | -8.5 |
Overall balance | 22.7 | -2.1 | 29.1 | -64.7 | -23.2 | -21.4 |
(In percent of GDP) | 4.7 | -0.4 | 5.8 | -13.2 | -4.4 | -3.9 |
Terms of trade (annual percent change) | -2.5 | 0.2 | 0.1 | -0.5 | 0.6 | 0.4 |
Gross official foreign reserves | ||||||
In millions of U.S. dollars | 214.9 | 212.8 | 241.9 | 192.3 | 169.1 | 147.7 |
(In months of next year’s total imports) | 7.8 | 8.2 | 9.6 | 6.7 | 5.5 | 4.7 |
Debt (in percent of GDP) | ||||||
Public debt (external and domestic) | 45.9 | 41.3 | 42.3 | 46.3 | 44.6 | 42.7 |
Of which: External debt | 40.5 | 36.4 | 36.2 | 38.5 | 35.1 | 31.6 |
External debt service ratio | 1.2 | 1.7 | 1.5 | 2.0 | 1.8 | 2.0 |
Exchange rates | ||||||
Nominal effective exchange rate (2005=100) | 93.5 | 94.6 | 93.4 | … | … | … |
Real effective exchange rate (2005=100) | 101.8 | 102.4 | 99.9 | … | … | … |
Memorandum items: | ||||||
Remittances (in percent of GDP) | 28.2 | 27.4 | 28.7 | 23.2 | 23.3 | 23.2 |
Tourism (in percent of GDP) | 9.0 | 9.2 | 7.4 | 0.4 | 7.3 | 7.5 |
FDI (in percent of GDP) | 4.9 | 0.1 | 0.7 | 0.9 | 0.9 | 0.8 |
Nominal GDP (millions of US$) | 485.9 | 516.8 | 504.1 | 491.0 | 526.1 | 551.9 |
GDP Growth 2018 – 2023 (Calendar Year Basis) | 0.5 | -0.9 | -3.0 | 0.2 | 3.5 | 2.8 |
Sources: Tonga authorities; and IMF staff estimates and projections. | ||||||
1 Fiscal year beginning July. | ||||||
2 Including preliminary data. | ||||||
3 CPI basket and methodology changed in September 2018. | ||||||
[1] Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: https://www.IMF.org/external/np/sec/misc/qualifiers.htm .