IMF Executive Board Concludes 2014 Article IV Consultation with Tonga | WPN World People News

On July 23, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Tonga.

A major cyclone hit Tonga in January 2014, causing damage estimated at 10 percent of GDP and depressing GDP growth in fiscal year (FY) 2013–14(to June 30) by about 1 percent. As a result, after sluggish growth of 0-1 percent in FY2012–13, the pace of recovery will rise to just 1.4 percent in FY2013–14 before strengthening to 3.4 percent in FY2014–15, led mainly by the post-cyclone reconstruction. This recovery is also supported by rising agricultural production and an improving outlook for tourism. Over the longer term, growth is expected to gradually converge to the historical trend of 1.7 percent, driven by remittances, tourism receipts, as well as credit growth. Risks to the near-term outlook are tilted to the downside.

Risk to the inflation outlook is low. Headline consumer price index (CPI) inflation has largely fluctuated between 1 to 2 percent since mid 2012, reflecting low global food prices, stable oil prices, and weak domestic demand. Inflation is expected to incrementally increase to 4-5 percent toward FY2018–19. The deleveraging cycle of the Tongan banks appears to be ending, with both lending and asset quality indicators substantially improving.

The projected fiscal cost relating to the cyclone will be broadly met by confirmed funding mainly from donor agencies. As a result, the budget is expected to record only small overall deficits in FY2013–14 and FY2014–15, estimated at around 0.6-0.7 percent of GDP. The external current account is projected to show a deficit of close to 3 percent of GDP in FY2013–14 and FY2014–15, largely financed by foreign direct investment (FDI) inflows. International reserves increased about threefold since 2008—to about 8 months of prospective imports. In the medium term, stronger imports and lower foreign grants will slightly decrease international reserves to 7 months of imports.

Executive Directors welcomed that Tonga’s economy is rebounding, supported by a recovery in agricultural exports and post-cyclone reconstruction activity. Directors noted that while the near-term focus should be on reconstruction, in the medium term, priority should be given to building buffers to enhance resilience to shocks. Business-enabling structural reforms will be key to achieving sustainable and robust growth.

Directors encouraged the authorities to maintain overall fiscal prudence while accommodating cyclone-related financing needs. They welcomed that the projected fiscal cost related to the cyclone will be broadly met by funding from development partners. Over the medium term, the fiscal strategy should aim to gradually increase the primary surplus, and to reduce the debt-to-GDP ratio. In this context, Directors underscored the need to continue with revenue reform and wage restraint, strengthen debt management, and avoid cost overruns associated with the South Pacific Games.

Directors considered the current accommodative monetary policy stance appropriate. They agreed that the National Reserve Bank of Tonga (NRBT) should consider tightening monetary conditions when signs of credit growth firm up. Directors welcomed the plan to expand the NRBT’s regulatory mandate to include nonbank financial institutions, and supported continued efforts to address bottlenecks in credit information and creditor rights. They noted that the authorities’ plan to lower the cost of credit through supportive measures, including by commercializing Tonga Development Bank, should be accompanied by robust safeguards to ensure the soundness of the bank.

In view of challenges posed by Tonga’s geographic remoteness and smallness, and its exposure to natural disasters, Directors encouraged the authorities to identify and strengthen new engines of growth. They underscored the need to continue to improve the business environment and to bolster confidence. Directors agreed that the promotion of foreign direct investment should focus on business-enabling structural reforms, while the use of tax incentives should be minimized and well targeted.

Source: International Monetary Fund