IMF Report Highlights Strong Economy and Challenges
Washington, DC – The International Monetary Fund (IMF) has wrapped up its Article IV consultation with Tonga, endorsing the staff appraisal without a formal meeting. The assessment sheds light on Tonga’s robust economic performance, primarily fuelled by remittance inflows and post-volcanic eruption reconstruction. While the nation’s economy is on the path to recovery, it faces certain challenges in the coming years.
Tonga’s economy has been resilient, with remittances and reconstruction activities serving as the pillars of its strength, following the Hunga Tonga-Hunga Ha’apai volcanic eruption in January 2022. The authorities’ decisive policy measures, international aid, and emergency financing from the IMF have been instrumental in mitigating the economic fallout. The post-eruption recovery in the fiscal year 2023 has been marked by strong domestic demand and increased tourist arrivals since the border reopened in August 2022. However, severe labour shortages and damaged tourism facilities have acted as significant hindrances to the recovery and have intensified inflation pressures.
While the short-term economic outlook remains positive, uncertainties loom on the horizon. Growth for the fiscal year 2024 is projected at 2.5 percent, driven by public investment. Nevertheless, the slow reconstruction of damaged tourism facilities is expected to keep tourism receipts as a share of GDP below pre-pandemic levels until fiscal year 2026. Additionally, the recovery in agricultural production is set to be sluggish due to labour shortages and adverse weather conditions related to El Niño. In the long term, Tonga’s growth is estimated at 1.2 percent, given its exposure to frequent natural disasters, ongoing emigration of workers, and limited economies of scale due to geographical constraints.
The Executive Directors of the IMF have endorsed the staff’s appraisal, recognizing Tonga’s strong economic performance and the challenges it faces. The rebound in economic activity following the reopening of borders in August 2022, driven by reconstruction projects, sustained remittances, and increased tourist arrivals, has been commended. However, the nation is grappling with severe labour shortages and the impact of damaged tourism facilities, leading to high and persistent inflation pressures.
The external position in fiscal year 2023 aligns with fundamentals and desirable policy settings, despite a current account deficit due to higher imports for reconstruction-related capital goods. Foreign exchange reserves have continued to grow, supported by official capital transfers and the IMF’s Rapid Credit Facility disbursement in July 2022.
The current expansionary fiscal stance is deemed appropriate, given the need to expedite reconstruction and protect the most vulnerable. However, in the fiscal year 2024, the primary balance is expected to revert to a deficit due to lower external grants and ongoing public reconstruction projects. The authorities are advised to focus budget execution on priority areas, such as reconstruction and social protection, while postponing non-urgent spending.
To ensure Tonga’s fiscal sustainability, gradual fiscal adjustments, including additional tax revenue mobilization and reductions in current expenditures, are essential. These adjustments should be combined with securing grants in line with historical levels and improving spending efficiency and fiscal transparency.
Monetary policy tightening is required to control inflation pressures, including increasing the policy rate and implementing additional liquidity absorption measures. Resuming the issuance of National Reserve Bank of Tonga (NRBT) notes and strengthening NRBT’s operational independence can help improve the monetary policy framework.
Addressing banks’ asset quality risks is critical, especially given the recent increase in non-performing loans (NPLs). Authorities should consider adopting a more conservative provisioning approach and requiring banks to submit concrete plans for NPL reduction. The NRBT should also enhance its risk-based supervision and broaden its regulatory and supervisory reach to include non-bank financial institutions.
Comprehensive structural reforms are essential to enhance climate resilience and stimulate private sector growth, which is vital for Tonga’s low growth potential. Stricter enforcement of Building Codes, property relocation to safer areas, and reducing gender inequality are crucial aspects of these reforms. Increased public investment in training and education is also recommended to address labour shortages. Furthermore, accelerating the adoption of digital technologies and reducing bureaucratic barriers are important to Tonga’s economic development.
In summary, Tonga’s economy has shown resilience and growth following the challenges posed by the volcanic eruption and the pandemic. However, it must address labour shortages, damaged tourism facilities, and inflation pressures while maintaining fiscal sustainability and pursuing comprehensive reforms for long-term economic growth and resilience.
