The Reserve Bank maintained its current accommodative monetary policy stance over the six months to August 2019. This was to ensure that it achieves its monetary policy objectives for maintaining internal and external stability, promoting a sound and stable financial system, and supporting economic growth.

The accommodative stance continues to encourage banks to utilize excess liquidity in the banking system for further lending to growth sectors to support economic growth. Internal stability was maintained with inflation remaining below the 5% reference rate during the review period. External stability was also achieved with foreign reserves at comfortable levels above the minimum 3 months of imports cover, and supported by competitive exchange rates. At the same time, the financial system remained sound and stable with no signs of overheating, supported by strong capital, adequate profitability, and high liquidity positions.

Following the latest national accounts rebase from the Tonga Statistics Department, Real GDP growth of 0.3% was recorded for 2017/18 following strong growth of 3.3% in 2016/17. However, indicators of domestic activity generally point to a recovery in 2018/19 for all sectors of the economy from the impacts of Tropical Cyclone Gita (TC Gita).

The annual headline inflation remained below the Reserve Bank’s reference rate of 5% throughout February to August 2019 averaging at 3.0% over the year. This was mostly driven by declining domestic prices reflecting the recovery in local food items from the impacts of TC Gita. Imported inflation was also relatively low during the six months to August 2019 as lower fuel prices partially offset the rise in other imported goods.

The Balance of the Overseas Exchange Transactions (OET) recorded a surplus of $18.3 million over the six months to August 2019. This stems from a higher inflow of official transfers mostly budget support, project grants, relief funds for TC Gita, and private remittances. Consequently, the official foreign reserves rose to $491.8 million in August 2019 from $473.5 million in February 2019 equivalent to 8.1 months of import cover. This is well above the minimum level of 3 months of imports cover.

The banking system continued to remain sound supported by strong capital position, adequate profitability, high liquidity, and low levels of non-performing loans. Over the six months to August 2019, the total banks' lending continued to rise to a new record high of $496.8 million while deposits slightly declined. The rise in lending was mainly for businesses in the professional & other services, transport, tourism, and wholesale & retail sectors. This reflected growth in private sector activities and business confidence. Total banks’ loans to deposit ratio also rose from 76.0% in February to 79.0% in August 2019. This is still lower than the 80% minimum threshold indicating there is still capacity for further lending by commercial banks. Non-performing loans however fell to 3.0% from 3.6% in February 2019. The weighted average interest rate spread narrowed during these 6 months as weighted average lending rates declined coupled with an increase in weighted average deposit rates.

Liquidity in the banking system (reserve money) declined by 2.9% to $311.3 million in August 2019 attributing to lower deposits by the commercial banks to the Reserve Banks vault. The Reserve Bank continues to maintain its policy rate at 0%, and the Statutory Reserves Deposit Ratio at 10%, while encouraging commercial banks to utilize the excess liquidity for further lending. Broad Money however rose to $602.3 million mostly in line with the movement in foreign reserves.

Government deposits continued to rise by 5.8% over the past six months to August 2019, resulting in a slight decline in net credit to Government. The inflow of budget support, project grants, and relief funds from development partners for the fiscal year 2018/19 drove the rise in Government deposits. This was further supported by revenues reforms and improved revenue collections by Government ministries.

Outlook

The Reserve Bank anticipates a stronger growth of 3.2% and 3.0% for the 2018/19 and 2019/20 fiscal years. This is largely based on the expected recovery of domestic performances from TC Gita specifically agriculture and fisheries, supported by an expected pick-up in economic activities in the industry and tertiary sectors owing to reconstruction and rehabilitation works from the damages of TC Gita. This is in addition to other donor-funded projects on the pipeline to be implemented such as the Road and infrastructure development project, the E-government project, and the Tonga Renewable Energy Project.

The annual inflation rate is projected to remain below the Reserve Bank's reference rate of 5% in the near to medium term. This stems from expected lower domestic prices reflecting the recovery in the primary sector from TC Gita. Additionally, the global fuel and commodity prices are also expected to remain low.

The upcoming principal loan repayments to EXIM Bank of China projected offshore investments and expected to pick up in the import bill for the implementation of infrastructure and development projects is expected to put pressure on the level of foreign reserves. However, the Reserve Bank projects that foreign reserves will remain comfortably above the 3 months of imports cover in the near to medium term supported by on-going receipts of budgetary support and grants funds from development partners, in addition to private remittances from our overseas diaspora.

Credit growth is expected to wind down for the year 2019/20 specifically with lending to private households, easing the concerns for overheating in the economy. However, there is still excess liquidity in the banking system indicating an available capacity for further lending by banks which the Reserve Bank is encouraging them to continue lending to growth sectors thus supporting economic growth. Non-performing loans are also expected to remain low.

Net credit to the Government may continue to decline on the back of higher deposits from budget support and grants from development partners, in addition to an expected higher revenue collection. The Reserve Bank continues to observe the current fiscal policy measures and its implication on the monetary policy objectives.

Tonga remains very vulnerable to natural disasters and external shocks. Tonga's resilience to tropical cyclones is low as they become more severe and more frequent over the years. Movements in global prices are expected to pass through imported prices and are potential sources of higher inflation. Nevertheless, the Reserve Bank will continue to update and review its forecasts regularly for the assessment of its monetary policy tools and instruments.

Given the recent developments and the outlook on the monetary policy targets, the Reserve Bank considers its current accommodative monetary policy stance to be appropriate in the medium term. The Reserve Bank will maintain its current monetary policy measures in the medium term to encourage the utilization of the excess liquidity in the banking system to increase lending, particularly to the growth sectors, to support domestic economic growth, the recovery from TC Gita, and strengthen the monetary policy transmission mechanism. Furthermore, the Reserve Bank will continue to monitor developments in the domestic and global economy closely, and adjust its monetary policy setting where necessary to maintain internal and external monetary stability and to promote a sound and efficient financial system that supports macroeconomic stability and economic growth.