The 2009/10 financial year has been a difficult and challenging year for Tonga’s economy. The impact of the global crisis continued to suppress domestic economic activity through the fall in remittances, decline in tourist receipts, credit contraction and stagnant exports. The impact of the global crisis also affected government revenue due to lower imports, which placed considerable strains on the government’s fiscal balance. Tonga was hard hit by the tsunami in September 2009 and cyclone Rene in February 2010 causing loss of life and severe damages. Moreover, the tragic disaster of the sinking of the MV Princess Ashika led to a major reallocation of government priorities and resources. The Ministry of Finance estimated economic growth to have contracted by 1.2 percent in 2009/10, the second consecutive year of negative growth experienced by the Tongan economy.

The weak economic conditions and lower imports supported the official foreign reserves over the year. The external balance of the country continued to improve, stability and confidence in the financial sector was maintained and inflation remained low. The level of official foreign exchange reserves continued to rise reaching 7.2 months of imports at the end of the financial year. The receipts of the IMF SDR allocations, official foreign aid, capital injections by banks and deferred import payments also propped up foreign reserves. Inflation has been generally moderated at 2.7 percent at the end of 2009/10 compared with 1.2 percent at the end of June 2009, and the average inflation fell to 1.7 percent from 5.6 percent in the previous year. Going forward, import payments is expected to pick up reducing the level of foreign reserves but will remain at adequate levels. Inflation is projected to rise, in line with the rebound in oil prices and the movement in the exchange rate.

Monetary policy continued to focus on achieving its twin objectives of maintaining an adequate level of foreign reserves and promoting low and stable inflation. Despite accomplishing the monetary policy objectives, the economy remained weak and private sector credit continued to fall. In 2009/10, the monetary policy remained accommodative, following the decision by the Reserve Bank in June 2009 to ease the monetary policy stance by ceasing the issue of the NRBT notes. In August 2009, the Statutory Required Reserves (SRD) was reduced from 10 percent to 5 percent and in January 2010, the Reserve Bank commenced paying 1 percent interest on banks’ exchange settlement account (ESA) balances over T$1 million. These measures were adopted to enable further reduction on domestic banks’ interest rates in order to support credit growth, stimulate economic activity and to assist borrowers who are facing financial difficulties. The Reserve Bank also reduced the interest rate on the repurchase facility for domestic banks from 4.5 percent to 1.9 percent in March 2010 in line with the decline in the inter-bank lending interest rate. These monetary policy measures assisted to bring about reductions in lending rates but credit growth continued to fall thus the anticipated impact of these monetary policy measures was not fully achieved. The basis of the policy decisions of the Reserve Bank are published on its six monthly Monetary Policy Statements.

However, in terms of its role as the bank regulator, progress was made in enhancing accountability and transparency within the financial system. The Reserve Bank revised its Prudential Statements No.1 and No.2 on Asset Quality and Credit Risk Grading to effectively implement the requirements of the International Financial Reporting Standards. Furthermore, the Prudential Statement No.4 on Disclosure was revised during the year to require banks to disclose the effective interest rate to their customers. The Reserve Bank’s supervision continued to focus on interest rates and credit risk management. The latter was largely attributed to the continued high level of non-performing loans, reflecting the impact of the slow down in economic activity and fall in remittances, which adversely affected the profitability and capital positions of the banks. This led to banks injecting additional capital to meet the Reserve Bank’s minimum capital requirements.

During the year, the Transaction Reporting Authority (TRA) in coordination with the Crown Law Department focused on the preparation for Tonga’s mutual evaluation by the Asia Pacific Group on Money Laundering (APG) which took place in November 2009. Following the mutual evaluation, the TRA worked together with the National Committee on Money Laundering and Terrorist Financing in preparing the response to the Mutual Evaluation report which was discussed and adopted at the APG Annual Meeting in July 2010.

The Reserve Bank continued working towards improving the quality of notes in circulation and acquired a new note processing machine to assist with the authentication and the fitness sorting of currency notes for circulation. The demand for currency notes by the public continued to increase during the year.

The Reserve Bank’s review of its internal control system during the year focused on its Information Technology (IT) system and engaged Pricewaterhouse Coopers to carry out a thorough IT General Control Audit review to ensure that the Bank’s IT system is secure and complies with international standards.

The Reserve Bank continued its effort to strengthen its capacity through supporting staff training on the job, in-house, locally and abroad. Staff participated in courses across a range of central banking functions, including bank supervision and capital adequacy, monetary policy formulation and forecasting, settlement and currency, human resource management and information technology. The annual accounts of the National Reserve Bank of Tonga continued to 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 expanded to T$200 million, an increase of 19.8 percent from the previous year mainly due to the increase in the level of official foreign reserves over the year. The Reserve Bank’s net operating profit fell by 47.3 percent from the previous year to T$1.3 million attributed to the decline in global interest rates to record low levels throughout the year, reflecting the prolonged impact of the global economic and financial crisis.

I would like to thank the staff of the Reserve Bank for their hard work, commitment and cooperation during 2009/10. I would also like to extend my appreciation to the Board of Directors for their continued support and guidance during the year. I wish to acknowledge the support from the Government of Tonga and the financial sector to ensure that stability in the financial system was maintained. I am grateful to the International Monetary Fund, World Bank, Asian Development Bank, Pacific Technical Assistance Centre (PFTAC), the Reserve Banks of Australia, New Zealand and Fiji, other regional central banks, the Bank of England Centre for Central Banking Studies, AusAID, NZAid and APG for the technical assistance provided to the National Reserve Bank of Tonga in 2009/10.

Governor Siosi Mafi