The Tongan economy faced a double crisis in 2020 from the COVID-19 pandemic and TC Harold. Despite the remarkable effort to remain COVID free over the past six months to August 2020, the economy was not spared the global impacts of the pandemic. International border lockdowns, disruptions to supply chains, acute shocks to aggregate demand and consumption activities, and high uncertainties from the prolonged state of the pandemic has severely affected domestic activities and economic developments. Because of these extraordinary challenges, the Reserve Bank has maintained its accommodative monetary policy stance during the review period to support macro-economic fundamentals and growth.

The outlook for the economy still remains gloomy, with an expected contraction for the fiscal year 2020 of 2.7%. However, this is an upward revision from the -6.3% projected in February 2020. The upward revision was due to better than expected outturns in real indicators, especially from the primary sector partly offsetting the downturns in the tourism industry and other related sectors. A worse than expected outcome is predicted for the fiscal year 2021 on account of the extended lockdown of the international border, halting tourism activities and reducing private sector operations, resulting in higher unemployment and household indebtedness. Nevertheless, the monetary policy outcomes so far have been satisfactory and sound. The annual headline inflation remained relatively low over the past six months, averaging at 0.1% in August 2020 below the Reserve Bank's reference rate of 5%. The fall in global oil prices coupled with the strong recovery in domestic food supply were the main drivers of the low inflation.

Gross official foreign reserves grew strongly over the past six months by $76.2 million to $556.1 million, from inflows of additional budget support and relief funds for TC Harold and the preparations for COVID-19. This kept official foreign reserves at very comfortable levels, sufficient to cover 9.6 months of import of merchandise goods and services which is above the Reserve Bank's minimum level of 3 months of import cover.

The Banking system remained sound and stable since the last review, supported by strong capital positions, adequate profitability, high liquidity, and low levels of nonperforming loans. Broad money has expanded by $34.6 million to $624.7 million over the six months to August 2020, as well as liquidity (reserve money) by $38.4 million to $336.3 million. The higher broad money corresponds to the growth in net foreign assets, while the growth in liquidity was mostly driven by higher currency in circulation and commercial 'banks' exchange settlement account balances.

Commercial Banks' lending slowed down in August 2020 by an annual growth rate of -1.8% to $487.6 million, as both business and household lending fell. On the other hand, deposits rose by $38.1 million, pushing the banks' total loans to deposit ratio down to 75.5%, which is below the Reserve Bank's minimum threshold of 80%. The weighted average interest rate spread continues to narrow over the past six months as lending rates declined coupled with higher deposit rates.

Government deposits rose by 28.6% over the past six months to August 2020 due to the inflow of budget support and relief funds. Consequently, net credit to the Government fell by 25.1%. The Government estimates a fiscal deficit for 2019/20 and 2020/21 of around $16.9 million and $37.4 million, respectively, given the expected loss of revenue streams from COVID-19. At the same time, Government expenditure is also projected to rise significantly in line with the preparations for COVID-19. The Government rolled out a $60 million stimulus package in April 2020 to assist economic and social sectors combat the adverse impacts of COVID-19.

Outlook

The Reserve Bank's forecast of an economic downturn in the Tongan economy still remains for the 2019/20 and 2020/21 fiscal years of -2.7% and -4.4%, respectively. This is largely based on the negative impacts of COVID-19 on various sectors of the economy, such as tourism, travel, transport and trade.

The inflation rate is projected to remain at low levels for the remainder of 2020 before gradually increasing in 2021 with the expected rebound in global oil prices. However, annual inflation is still expected to remain below the 5% reference rate up to June 2021.

Foreign reserves is likely to continue growing with more budget support and grants expected for the 2020/21 fiscal year. This will keep foreign reserves at very comfortable levels above the minimum of 3 months of import cover in the near term.

Credit growth is anticipated to be subdued in 2020/21 due to the uncertainties from COVID-19 discouraging borrowers from taking out credit while banks are becoming more risk-averse. Meanwhile, there is still excess liquidity in the banking system for further prudent lending. Commercial banks have extended their relief packages for their affected clients, which will help manage low levels of nonperforming loans.

Fiscal policy will also be expansionary over the medium term as the Government takes action to combat COVID-19, mitigate its economic impacts on the country, and provide relief for those affected by TC Harold. These efforts are also supported by donor funds and budget support from development partners. The Reserve Bank will closely monitor the implications of the fiscal policy measures on its monetary policy objectives.

Nevertheless, the outlook is largely precarious as high uncertainties surrounding the global pandemic still remains. Although there is some positive development on the vaccine, but having it available on a world wide scale remains a challenge. Emerging risks in cybersecurity, anti-money laundering and indebtedness threaten financial stability. Tonga's vulnerability to external shocks in the commodity markets and financial markets are also downside risks. At the same time, we are constantly battling climate change as part of our daily lives, with tropical cyclones expected to be more frequent and more severe, resulting in significant set-backs to domestic developments.

Given the recent developments and outlook, 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 to support macroeconomic growth while at the same time, maintain financial stability. The Reserve Bank remains vigilant by closely monitoring economic and financial developments and stands ready to provide corrective measures where necessary to achieve its monetary policy objectives.