The Reserve Bank reviewed Tonga’s economic growth outlook based on the latest real sector indicators available. A deeper contraction of 2.5% is anticipated for FY2021 compared to the 2.0% official forecast in the February 2021 MPS. The downgrade is mainly due to weaker than expected outturns, mostly in the primary and industry sectors. Additionally, the recent outbreak of the Delta variant in neighbouring countries further affected logistics, travel, and trade, derailing recovery in tourism and trade activities.

The IMF, in its October 2021 WEO, slightly revised global growth down to 5.9% from 6.0% in the April 2021 WEO. The slight revision stems mostly from disruptions to global supply chains and trading performances. However, global economic growth is expected to moderate at 4.9% in FY2022 compared to 4.4% in the previous WEO.

The Reserve Bank continued to maintain its accommodative monetary policy stance throughout the six months to August 2021. Negative impacts of the global pandemic are considered in reviewing the Reserve Bank’s stance to counter these adverse economic effects.

The annual headline inflation rose above the Reserve Bank’s reference rate of 5.0% during the six months to August 2021. The rebound in global oil prices and the rising imported food prices were the main drivers of the higher inflation. Disruptions to shipping schedules and logistics will further affect inflation, which is evident in the latest annual headline inflation rate of 7.0% as of the end of August 2021.

Gross official foreign reserves reported a record high level of $751.7 million, equivalent to 13.1 months of imports cover, well above the minimum threshold of 3 months. Large inflows of donor funds, budget support, grant, remittances, and other financial assistance for the COVID-19 preparations and TC Harold assistance continue to buttress these significant movements.

The financial system remained sound during the six months to August 2021. This was reflected through banks’ strong capital position, excess liquidity, and low levels of non-performing loans. Both broad money and liquidity (reserve money) rose to new high levels of $779.2 million and $515.0 million, respectively. Broad money rose on the back of strong growth in the foreign reserves, whilst the higher deposits made by commercial banks to the Reserve Bank vault supported the build-up in liquidity.

Loans extended by the commercial banks slowed in the six months to August 2021 as a result of lower business and household loans. Deposits, however, rose significantly in line with the higher remittance receipts, Government funds, and liquidity levels. All categories of deposits drove the overall increase, particularly demand and term deposits. As such, the banks’ total loans to deposit ratio was at 59.0% below the Reserve Bank’s minimum threshold of 80%. The weighted average interest rate spread widened as the deposit rates fell while lending rates rose.

Outlook

The Reserve Bank anticipates that GDP growth will recover moderately by 1.2% in FY2022, which is lower than the forecast of 1.6% in the February 2021 MPS. The slower recovery is underpinned by the resurgence of highly transmittable variants globally, further delaying the global exit from the pandemic.

The inflation rate is expected to remain above the 5% reference rate in the near term, as oil prices continue to rise in line with economies around the globe facing supply chain disruptions and other trade restrictions. These are external factors beyond the Reserve Bank’s control. However, the Reserve Bank is of the view that this inflationary pressure is transitory, and headline inflation is expected to fall below the reference rate by the first quarter of 2022.

Foreign reserves will remain at comfortable levels above the minimum 3 months of import cover in the near term, despite an expected rise in imports of goods and services. The delayed receipt of budget support and grants from development partners, which are now scheduled for the end of FY2022, supports this outlook.

Credit growth is projected to remain subdued in the coming months as both borrowers, and the banks remain cautious of COVID-19 related uncertainties. However, a few Government projects in the pipeline may support a return to positive credit growth by the end of FY2022. Non-performing loans are expected to be contained as some commercial banks extend their COVID-19 relief packages for affected clients. The Reserve Bank continues to closely monitor banks’ asset quality and ensure adequate provisions are in place to absorb any potential shocks in the financial system.

Fiscal policy remains expansionary with the Government’s ongoing efforts to mitigate the economic impacts of COVID-19 on businesses and vulnerable groups. Vaccination rollouts are expected to further boost consumer confidence and will be considered for the safe re-opening of the international border.

In light of the above developments and projections, 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 maintaining financial stability. The Reserve Bank remains vigilant in closely monitoring economic and financial developments and stands ready to adjust its monetary policy settings to achieve its monetary policy objectives.