The Tongan economy during 2007/08 is estimated to have returned to modest growth, following several large shocks to the economy in previous years. A return to economic stability so shortly following the civil unrest in November 2006, a poor agricultural season and large scale redundancies in the civil service reflects in part decisions of policy makers.

The National Reserve Bank of Tonga played its part, ensuring that businesses affected by the civil disturbance were able to access funds, while maintaining adequate foreign reserves. At times these goals were in conflict with each other but I believe we managed to address both issues with minimal disturbance to the stability of the financial system. I am pleased to report that despite many challenges, the external balance of the country was maintained. The level of official foreign exchange reserves remained above 3 months of import cover throughout 2007/08 though was declining at the end of the financial year. The outlook is for improving foreign reserve levels on the back of anticipated increase in capital receipts in the next financial year.

This financial year has been characterized by high inflation as the rising cost of fuel and food had a significant impact on the local economy. The Reserve Bank’s monetary policy measures played its part, containing inflation to 12 percent despite international commodity prices more than doubling, and by the end of the financial year signs of inflation slowing were evident. As oil and food prices drop on international markets we expect that inflation will be well under control in the next financial year.

Overall, the stability of the Tongan economy and financial system was sound throughout the financial year despite some pockets of illiquidity. To address the perceived lack of liquidity and strengthen the banks’ liquidity management policies, the Reserve Bank encouraged the banks to purchase Government of Tonga bonds, against which they can enter into repurchase agreements with the Reserve Bank. The terms and conditions of the Reserve Bank’s repurchase agreement facility were revised and the repurchase agreement rate was reduced to 10 percent in August to reflect lower interbank rates. Further, large import and capital payments were staggered to ensure adequate liquidity in the system. As capital payments enter the banking system, and large outflows are cleared we expect liquidity to stabilize.

In an important milestone in the development of Tonga’s financial system, the National Reserve Bank (Amendment) Act 2007 was gazetted and came into effect in February 2008. This Act strengthens the institutional capacity of the Reserve Bank and ensures greater autonomy in the conduct of monetary policy. The Act also strengthens the accountability and transparency of the Reserve Bank in exercising its powers. The Reserve Bank is required to publish every six months a Monetary Policy Statement; the first of which was published in September 2007. The release of regular Statements on Monetary Policy will provide greater clarity on the policy decisions of the Reserve Bank, and greater understanding of the state of the Tongan economy and financial system.

The Reserve Bank in its capacity as bank supervisor, issued two important prudential standards on liquidity management and the disclosure of interest rates and fees and charges by banks to ensure that liquidity risk management practices were in line with international best practice and to foster market discipline.

To combat money laundering and terrorist financing, the Reserve Bank continued to work with the Crown Law Department on the amendments to the Anti-Money Laundering and Combating of Terrorist Financing (AMLCFT) related Acts in preparation for Tonga’s mutual evaluation by the Asia Pacific Group on Money Laundering (APG) in 2009.

The Reserve Bank successfully completed its administrative targets for the year, including the successful hosting of the South Pacific Central Bank Governors’ Annual Meeting in December 2007 – the first time this has been held in Tonga. The Reserve Bank also, successfully completed its work on the new design of currency notes and its preparation for the first issue of the one hundred pa’anga note with the portrait of King George Tupou V on it. The new one hundred pa’anga note was issued to mark the coronation of His Majesty. The Reserve Bank continued to carry out its regular functions that contribute to monetary and financial sector stability. These functions include the supply of Tongan currency, provision of daily settlement for inter-bank transactions, foreign exchange operations with the government and the banks, foreign exchange control administration and registrar of government bonds. In order to strengthen the security and efficiency of its international payment system, the Reserve Bank upgraded its swift system during the year.

The Reserve Bank places considerable emphasis on developing the existing high skills base of its staff, through external and in-house training. Staff participated in courses across the range of central banking functions, including bank supervision, reserves management, remittances, anti-money laundering, balance of payments reporting, human resource management and information technology.

The annual accounts of the National Reserve Bank of Tonga comply with the requirements of the International Financial Reporting Standards, with the exception of the treatment of foreign currency gains and losses, which meets the provisions of the National Reserve Bank of Tonga Act, 1988. The Reserve Bank’s balance sheet contracted to T$127.2 million, a 4.5 percent decrease from the previous year attributed mainly to the decrease in the level of holding of Government of Tonga bonds. The Reserve Bank’s operating profit, reached T$3.8 million, an increase of 4.8 percent over the previous year.

I thank the staff of the Reserve Bank for their efforts during a very challenging period for the Reserve Bank and the Tongan economy. I also thank the government and members of the financial sector for their part in ensuring that confidence and stability in the system was maintained. Appreciation is also extended to the members of the Bank’s Board for their continued support during the year. The assistance from the International Monetary Fund, Pacific Financial Technical Assistance Centre, the Reserve Banks of Australia, New Zealand and Fiji, other regional central banks, the Bank of England Centre for Central Banking Studies, AusAID, NZAid, AUSTRAC, AMLAT and the Pacific Anti- Money Laundering Project is also gratefully acknowledged.

Governor Siosi Mafi