Tonga’s economy below the regional level in last two decades

Lipooti 'a e IMF: 'Oku tu'u lavea faka'ekanomika 'a Tonga

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Angana Banerji, Senior Economist with the IMF

An International Monetary Fund (IMF) staff team led by Angana Banerji visited Nuku-alofa from February 10−20, 2020 to conduct the 2020 Article IV consultations for Tonga.

“Tonga’s economy is gradually recovering after stagnating in FY2018 due to the effects of Cyclone Gita. Growth is estimated at 3 percent in FY2019, driven by stronger consumption due to remittance inflows, supportive monetary policy and credit growth. Although the recovery has been slower than expected due to a loss in market share for agricultural exports and slower growth in partner/remitting countries, commendable policy management has delivered strong macro financial outcomes: low inflation, a fourth consecutive budget surplus; and financial sector stability.

“Tonga’s growth potential, however, is below what it could be. The economy has been growing well below the regional average for the past two decades and is constrained by a narrow production base, a lack of economies of scale and high vulnerability to natural disasters. The loss of skilled workers to emigration or seasonal worker programs and the social and economic limitations on the ability of women (who have more years of schooling) to contribute effectively to the economy, also hurt growth prospects. Remittances are a mixed blessing—while they help to reduce poverty and finance Tonga’s heavy import dependence, remittances are keeping the economy caught in a low-growth equilibrium.

“The economic outlook is, therefore, modest and fragile due to slower growth in remitting/ partner countries, and high vulnerability to natural disasters. Tonga is also in high debt distress with repayments set to spike from 2024 onward. In the medium-term, growth is expected to gradually decline to an estimated potential rate of 1.8 percent, unless there is a concerted effort to remove bottlenecks hampering private sector development. Weak export competitiveness, large debt repayments, and high import bills due to large infrastructure needs will keep current account deficits high and rising for the foreseeable future. Inflation, however, is likely to remain well below the reference rate of 5 percent, due to lower global food and fuel prices.

“The budget will need to deliver higher surpluses to allow a sufficient buildup of fiscal buffers for debt repayment and emergency funds for climate-related shocks. High-quality consolidation measures include: reducing tax exemptions; updating excise tax rates, fees and charges; strengthening revenue administration and reorienting current spending policies toward improving public sector capacity and value-for- money, including by rationalizing civil service functions; identifying and staffing critical positions; and gradually aligning compensation with market pay levels to reduce turnover. Faster implementation of investments requires careful and consistent prioritization, improved cross-governmental coordination, and more effective use of procurement regulations.

“However, larger fiscal surpluses alone will not be sufficient to achieve climate resilience goals. The IMF’s recent Climate Change Policy Assessment (CCPA) estimates that climate-resilience projects will cost some 140 percent of 2018 GDP, of which donor funding has been committed for about half. Meeting Tonga’s development goals by 2030 will require an additional annual spending of 5 percent of 2018 GDP by 2030. There is also a need to increase the national Emergency Fund to around 1 percent of GDP, and set aside sufficient funds for infrastructure maintenance. Donor financing—in the form of grants—will be essential to fill the gap without worsening debt dynamics.

“A more durable solution to overcoming financing and capacity constraints would be to grow the private sector to expand the tax base over time, and support government efforts to achieve resilience. Reform needs are manifold in several key areas: (i) improving access to skilled labor, land, infrastructure, credit, and technology; (ii) easing barriers to entry by strengthening official capacity and female labor force participation; and (iii) reducing investment uncertainty by improving climate resilience and insolvency regimes. In particular, improvement of the operation of the Tongan land market is critical. The complexity, non-transparency and delays in the operation of the leasehold market are a major hurdle for domestic and foreign investors. Land-related concerns have also stalled the approval of high-priority regulations, such as the insolvency law, which further deters investment. Modernizing and clarifying the land lease process by improving transparency and predictability in the land-lease market, and clarity regarding ownership rights, could help maximize the use of vacant or underutilized land. Such modernization and enhanced clarity would provide greater confidence for both domestic and foreign investors regarding their rights and improve incentives to ensure that structures built on such land are climate resilient.

“Given the importance of remittances for the economy, the AML/CFT framework should be strengthened as a matter of priority. Efforts to improve financial sector supervision should also continue.

“The IMF team expresses its sincere gratitude to the Government of Tonga and the National Reserve Bank of Tonga for their warm hospitality and constructive discussions.”

Main Points

  • Tonga’s economy is slowly recovering but the growth outlook is modest and fragile due to slower global growth, weaker than expected agricultural exports, and significant downside risks including from natural disasters.
  • Authorities commendable policy management has delivered low inflation, a fourth consecutive budget surplus and financial sector stability.
  • Ambitious fiscal consolidation is needed to ensure debt sustainability while boosting climate resilience. Strong reforms to support private sector growth would also help improve growth potential and increase fiscal buffers over time.

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