In the past six months to August 2018, the Reserve Bank maintained its current accommodative monetary policy stance. This supported meeting the monetary policy objectives by ensuring an adequate level of foreign reserves was maintained above 3 months of import cover and the exchange rate remained competitive. Inflationary pressure remains as the inflation rate was slightly above the reference rate of 5% per annum in August, however, it is expected to fall below the reference rate in the near term. Despite the strong credit growth over the year, financial stability was maintained with no signs of overheating and there is still excess liquidity in the banking system.

The Reserve Banks’ outlook for a stronger real Gross Domestic Product (GDP) growth of 3.1% in 2017/18 remains. The favorable growth is anticipated to be led by the trade, agricultural, utility, fisheries, transport & communication and ownership of dwellings sectors. Growth is expected to remain strong in 2017/18, supported mainly by the implementation of infrastructure projects and ongoing housing construction projects, upgraded power supply, and improved performance in the above-mentioned sectors despite the impact of Tropical Cyclone (TC) Gita. The agricultural production further increased over the year which was attributed mainly to the favourable weather conditions resulting in better yields for squash, taro, yam, and watermelon before TC Gita struck Tonga. According to the Domestic Market Survey Report for 2017/18, the total agricultural produce available for sale at the domestic market increased by 1,247.1 tonnes (40.5%) when compared to 2016/17. The total agricultural export volume also rose over the year to June 2018 by 1,362.9 tonnes (11.8%) compared to a growth of 33.0% in the year ended June 2017. Growth was driven mainly by higher exported volumes of squash which rose by 1,575.6 tonnes (38.3%), followed by the exports of taro and yam which increased by 803.7 tonnes (172.1%) and 208.4 tonnes (12.2%) respectively.

The annual headline inflation remained high over the past several months since a hike to 9.8% in March 2018, mainly driven by local prices due to the impact of Tropical Cyclone (TC) Gita on the local food supply. However, in August 2018, the annual headline inflation rate slowed to 5.7%.

Over the past six months to August 2018, the overall Overseas Exchange Transactions (OET) balance recorded a surplus of $27.0 million. This corresponds to an increase in the foreign reserves from $448.0 million in February 2018 to $475.0 million in August 2018. The financial account recorded the highest surplus, followed by the surpluses in the capital account and the current account.

The official foreign reserves was sufficient to cover 7.7 months of import of merchandise goods and services, which remained above the Reserve Bank’s minimum of 3 months of import. In the year ended terms, gross official foreign reserves rose by $70.0 million. This was due mainly to higher remittance receipts, and higher receipts of foreign aid from donor partners and budgetary support for the Government.

Over the 6 months to August 2018, the banking system continued to remain sound. A strong capital position was maintained, supported by banks’ comfortable profitability, high liquidity, and low non-performing loans. The total banks’ lending reached a new high record in August 2018. Similarly, the deposits continued to rise to new heights which are in line with the increase in the foreign reserves. The weighted average interest rate spread widened over the 6 months to August 2018.

Liquidity in the banking system (reserve money) also hit a new high record of $334.2 million, attributed mainly to higher deposits by the commercial banks to the Reserve Banks vault supported by higher Statutory Required Deposits (SRD). Broad money rose to its second peak point of $606.0 million, supported by an increase in both net foreign assets and net domestic assets. The receipts of TC Gita relief funds, budgetary support and project funds contributed to higher foreign reserves and the rise in net foreign assets whereas a decline in Government deposits drove the rise in net domestic assets. The banks’ total loans to deposit ratio remained below the 80% minimum loan to deposit ratio which indicates excess liquidity in the banking system remains and that there is capacity for further lending by the banks.

The net credit to Government from the banking system data rose over the past six months, due to a decrease in Government deposits. The payout of the Government’s TC Gita recovery assistance, the implementation of donor funded projects and the delay in budget support receipts that was budgeted to be received before June 2018 may have contributed to this lower deposits.

Outlook

The anticipated stronger growth of 4.5% for 2018/19 remains due to the projected growth from various sectors such as the agricultural, construction, trade, utilities, mining & quarrying, transport & communication and ownership of dwellings sector. The latest climate update by the Tonga Meteorological Service2 indicated that there is approximately a 70% chance of El Niño occurring in 2018. Rainfall forecast is expected to fall below average for the remainder of 2018 and to continue into the first quarter of 2019. This may have a negative impact on the primary sector and other sectors of the economy.

The Reserve Bank anticipates inflationary pressures to remain in the near term due to the impact of TC Gita on the domestic food supply and is expected to fall below the Reserve Bank’s inflation reference rate of 5% per annum at the beginning of 2019. The developments in global food and oil prices may pose a risk to this outlook. Additionally, the vulnerability of Tonga to natural disasters poses a risk to the local food prices and consequently the inflation outlook. The Reserve Bank will closely monitor the sources of higher inflation which include assessing the effects of exchange rates, new tax introduced and also the businesses’ profit margins.

The level of foreign reserves is expected to remain at comfortable levels well above the minimum of 3 months of import cover supported by expected higher receipts of budgetary support and grant funds from development partners and expected higher receipts of remittances. This will be partially offset by the projected rise in imports.

The Reserve Bank projects a credit growth of 13% for 2018/19. Seasonal festivals and cultural obligations coupled with the ongoing business endeavours will continue to support credit growth. The excess liquidity in the banking system remains indicating available capacity for further lending by banks. The Reserve Bank will continue to closely monitor the credit growth and broad money movements to ensure financial and macroeconomic stability are maintained and that there is no overheating in the economy. Non-performing loans are also likely to decline in the near future.

Net credit to the Government is also anticipated to decrease as a result of expected Government budgetary support and Government grants receipts, as well as improved Government revenue collection. The Reserve Bank will closely monitor the implication of the fiscal policy measures on the monetary policy objectives.

Given the recent developments and the outlook on the monetary policy targets, the current monetary policy stance is considered appropriate in the medium term. Therefore, the Reserve Bank will maintain its current monetary policy measures in the medium term in order to encourage the utilisation of the excess liquidity in the banking system to increase lending, particularly to the growth sectors, in order to support domestic economic growth and the recovery from TC Gita, and strengthen the monetary policy transmission mechanism. Furthermore, the Reserve Bank will continue to closely monitor developments in the domestic and global economy, and update its monetary policy setting to maintain internal and external monetary stability and to promote a sound and efficient financial system in order to support macroeconomic stability and economic growth.