During the six months to August 2016, the National Reserve Bank of Tonga (NRBT) maintained its accommodative monetary policy stance. The NRBT’s objectives to maintain internal and external monetary stability, promote financial stability and a sound and efficient financial system, and to conduct its activities in a manner that supports macroeconomic stability and economic growth by ensuring adequate level of foreign reserves, were achieved although inflation had significantly increased in July due mainly to the enforcement of the new excise tax and customs duty introduced in July 2016.

The domestic economy experienced favourable growth. The NRBT’s economic growth estimates for 2014/15 and 2015/16 remained positive and similarly the outlook is for stronger growth over the next two years 2016/17 to 2017/18. The on-going construction activities and strong performance in the trade and tourism sectors are anticipated to drive growth. The Statistics Department has yet to release the official estimates of real GDP for 2014/15 and 2015/16.

The NRBT estimated a stronger real GDP growth of 3.4% in 2015/16 coinciding with the 3.1% growth projected by the IMF Article IV 2016 mission. This is an upward revision from an estimate of 3.3% in the February 2016 MPS, which reflects an expanding primary sector mainly in the fishing and agricultural sectors and a rebound in the forestry sector. In addition, the events that took place during the year such as the King’s coronation, annual church conferences, family and village reunions and the celebration of the Tupou College’s 150th Anniversary boosted activities in the tourism and trade sectors.

The annual headline inflation rose by 5.1% in August 2016 which compares to a period of deflation reported in the NRBT’s previous Monetary Policy Statement, and is still below the NRBT’s reference range of 6-8%. Over the past six months to August 2016, the overall balance of Overseas Exchange Transactions (OET), which is equivalent to the net change in the foreign reserves, was a surplus of $37.7 million. This was more than double the surplus recorded for the six months to February 2016 of $17.6 million. The improvement in the current account, and the capital account contributed to the higher overall surplus.

Gross official foreign reserves therefore rose to $366.3 million in August 2016, compared to $328.5 million in February 2016. This was sufficient to cover 9.2 months of imports, well above the NRBT’s minimum range of 3-4 months. In year ended terms, gross official foreign reserves rose by $55.4 million (17.8%). The lower deficit in the current account balance as a result of higher remittances, higher receipt of foreign aid and budgetary support for the government from donor partners, contributed to the comfortable level of foreign reserves over the past year.

The banking system remained sound over the 6 months to August 2016 as banks continued to be profitable with strong liquidity and capital positions being maintained. Banks’ lending grew by $23.3 million (7.0%) over the 6 months to August due to growth in both household and business loans, supporting economic activities.

The higher foreign reserves during the 6 months to August 2016 contributed to the continued high liquidity in the banking system. Broad money rose over the 6 months to August 2016 by $34.6 million (7.6%) to another record high of $491 million. This was driven by a $47.6 million (14.4%) rise in net foreign assets, offsetting a $13.1 million (10.3%) fall in net domestic assets. The banking system liquidity (reserve money) increased over the past 6 months to August 2016 by $9 million (3.5%) to a record high of $267.2 million. This coincides with higher deposits during the period. Total loans to deposit ratio for the banking system slightly increased to 73.7% in August 2016 from 73.6% in February 2016. This is still below the NRBT’s minimum floor of 80% effective from 1st July 2016 to be met by December 2016, as the growth in deposits of 6.8% was offset by a 7% growth in bank loans, indicating excess liquidity for the banking system remains.

Banking system data shows the net credit to government fell by $17.7 million (36.6%) over the 6 months to August 2016 due mainly to higher government deposits during the period.

The 2016/17 real GDP growth estimate has been revised up to 3.6% compared to the February 2016 MPS projection of 1.9%. This upward revision of growth is driven mainly by the outlook for stronger growths in financial intermediation, construction, tourism, trade and agricultural sectors. This estimate is stronger than the 2016 IMF Article IV’s real GDP growth estimate of 2.5% - 3.0% over the medium term.

The annual headline inflation rate is expected to be above 6% in the remaining months of 2016 and to fall to around 4% in the beginning of 2017/18. This is attributed to the continued shortage of Kava Tonga, the new customs duty and excise tax which will remain in force, and oil prices are expected to gradually increase from an average of US$43/barrel in 2016 to US$51/barrel in 2017 according to the IMF October 2016 WEO.

The level of foreign reserves is projected to remain comfortably above the minimum range of 3 to 4 months of imports until June 2017. Remittances and travel receipts are expected to remain high due to upcoming festivities. Export proceeds are also expected to rise, supported by the positive growth in the agricultural and fisheries sectors, which will partially offset the rising import payments.

Credit growth for 2016/17 was revised upwards from 11% to 15%, which is higher than the projection by the IMF Article IV of 10.8% for 2016/17. The NRBT’s policy measure imposing a minimum requirement on banks’ loans/deposit ratios effective 1st July 2016 should encourage further lending and support the continued growth in credit and broad money. The NRBT’s initiative to encourage lending to Micro, Small and Medium Enterprises is also expected to contribute to credit growth. At the same time, structural reforms in various sectors as well as other impediments to lending such as the improvement to the land administrative system and the bankruptcy laws would improve the confidence of the banks to lend further in a prudent manner.

Net credit to the government is expected to fall, due to anticipated budgetary support and government grants receipts.

Given the recent developments and the outlook on the monetary policy targets, the NRBT considers the current accommodative monetary policy stance to be appropriate in the medium term. The NRBT will remain vigilant and closely monitor early signs of vulnerabilities.