OREANDA-NEWS. June 22, 2016. Executive Board of the International Monetary Fund (IMF) concluded the 2016 Article IV consultation1 with Tonga.

The Tongan economy has been rebounding since a contraction in FY2013.2 Growth accelerated from 2.1 percent in FY2014 to 3.7 percent in FY2015, supported by construction, tourism, strong remittances, and strong private credit growth, notwithstanding weather-related disruptions to agricultural production. Inflation declined to -0.3 percent at end-February 2016, reflecting lower global food and fuel prices. The countrys external position remains strong, with reserves supported by strong remittances, donor aid, and low global fuel prices.

Real GDP is projected to grow at 3.1 percent in FY2015/16, driven by agriculture and construction sectors, as well as private consumption. Over the medium term, growth would stay around 2.53.0 percent, supported mainly by construction activities related to the preparation for the South Pacific Games (SPG). Low inflation is projected to continue over the medium term in line with global commodity prices.

The balance of risks is tilted toward the downside. A protracted period of slower growth in advanced and emerging market economies, particularly in Australia and New Zealand, could lead to lower aid, remittances, and tourism receipts. On the domestic side, a large increase in current spending and potential cost overruns related to SPG could weaken fiscal sustainability and raise public debt. Slippages in the reform process could affect donor aid and create a fiscal financing gap, while natural disasters could take a toll on the economy.

Executive Board Assessment3

The Executive Directors welcomed Tongas improved macroeconomic performance and favorable outlook. However, they noted that given the countrys small size, remoteness, and exposure to natural shocks, it remains vulnerable to risks. Directors agreed that policy priorities ahead should focus on building buffers and implementing structural reforms to strengthen the economys resilience, safeguard macroeconomic and financial stability, and boost potential growth.

Directors emphasized the importance of addressing fiscal risks and gradually building buffers. They welcomed the authorities commitment to rein in the wage bill and avoid cost overruns. They also encouraged continued reliance on concessional financing for capital spending, including grant financing for the South Pacific Games. Directors saw a need for further improvements in debt management as well as broader reforms to increase revenue and raise the efficiency of public spending to create the fiscal space needed for investment in infrastructure and human capital.

Directors considered the current accommodative monetary policy stance to be appropriate. However, they encouraged the authorities to be ready to mop up excess liquidity should signs of overheating emerge. Directors also encouraged the central bank to improve its monetary policy framework by introducing a policy interest rate, developing monetary and macro-prudential policy instruments, and announcing a new lower indicative reference rate for inflation to help anchor inflation in the medium term. They underscored that maintaining gross international reserves at the current level would help safeguard external stability. Directors welcomed the continued progress made by the central bank in upgrading its supervisory, regulatory, and legal frameworks for the financial sector, and called for further steps to expand its oversight over nonbanks.

Directors emphasized that structural policies should aim at raising growth potential by expanding opportunities for private sector development. They supported the efforts to enhance financial inclusion and to promote private credit, but highlighted the need to exercise caution in the application of government lending schemes. Directors encouraged the authorities to develop a broader reform strategy to improve the business climate and to make further progress in natural disaster preparedness. They also underscored the need to improve the quality and timeliness of data and encouraged the effective use of technical assistance from the Fund and development partners.