The Reserve Bank’s monetary policy remained accommodative over the past six months. The Bank’s outlook was for annual inflation to remain below 6 per cent and for foreign reserves to remain above four months of imports.

Gross official foreign reserves increased over the past six months, to $258 million. The level of foreign reserves was equivalent to 9.1 months of imports, well in excess of the NRBT benchmark of 3 to 4 months of imports. Consumer price inflation rose to 1.1 per cent over the year ended February 2013. The NRBT achieved its primary objectives of maintaining an adequate level of foreign reserves and promoting low and stable inflation.

Global economic growth slowed to 3.2 per cent in calendar year 2012, from 4.0 per cent in 2011. Policymakers avoided a breakup of the euro area and, more recently, sharp cuts to US government spending, both of which would have resulted in lower growth.

The provisional national accounts data for the 2012 financial year show that Tonga’s real Gross Domestic Product (GDP) grew by 0.8 per cent. The figure is stronger than the forecasts in the NRBT’s September 2012 Monetary Policy Statement because the agriculture and construction industries performed better than expected. However, this growth compares poorly with GDP growth globally and throughout the South Pacific.

As has been the case since 2009, the industrial sector recorded the strongest growth of the three main sectors, with much of the growth coming from public sector construction activity. The primary sector expanded by 0.5 per cent over the year, and growth in the agricultural component was the fastest for five years. Performance in the services sector was mixed. The industries most exposed to tourism generally recorded flat outcomes, and activity in the finance sector contracted. The trade sector reported small growth, despite ongoing falls in credit and a modest level of remittances.

Liquidity in the banking system rose over the six months to February 2013, continuing the build-up that began in 2009. The initial increases in banking sector liquidity helped to reduce banks’ lending rates, but more recent increases have been less effective. So, to help reduce interest rates further and strengthen banks’ incentive to lend, the NRBT removed all interest payments on banks’ Exchange Settlement Accounts in November last year. Since then some banks have indeed started offering loans at lower rates or longer terms. The lower interest rates do not yet show in the official data, probably because the take-up has so far been small compared with the stock of existing loans.

Outlook

The NRBT expects that for the 2013 financial year, Tonga will record real GDP growth that is similar to last year, or slightly lower. Growth is then projected to strengthen in the 2014 financial year.

A tighter government budget is likely to exert a drag on growth in the near term, mostly through an anticipated fall in construction activity. However, primary sector activity is expected to strengthen, as positive signs have been emerging from exports data recently and weather conditions have been favorable over the year. Growth in the services sector is expected to be modest, limited by a reduction in public sector activity. However, growth in the trade industry stands to benefit from a pickup in credit growth and remittances. The industries exposed most to tourism are also likely to record positive outcomes.

Year-ended growth in banking system credit is forecast to be slightly positive by early next year. The improvement reflects that the NRBT’s current monetary policy settings are accommodative, the drag created by the post-crisis reduction in banks’ risk appetite seems to be fading, and recent discussions with banks suggest that several large loans are in the pipeline for public enterprises.

The level of foreign reserves is forecast to rise over calendar year 2013 and to fall over 2014. The profile stems from four key expectations: Government foreign debt repayments are expected to rise, with repayments of the large loan from the Export-Import Bank of China commencing in September 2013; donor support is projected to decline from its unusually high levels of the past few years; remittances are expected to rise only slightly, underpinned by global growth and positive developments in the US; and imports are forecast to rise, on the back of the increase in remittances and the anticipated pick up in credit growth. Nevertheless, foreign exchange reserves will remain comfortably above four months of import cover in 2013 and 2014.

The NRBT projects an increase in headline inflation to around 5 per cent in the near term, with Tonga Power realigning electricity prices to diesel prices in the June quarter. Continued drought conditions in New Zealand’s north island could increase the rate of imported food inflation in Tonga and throughout the Pacific region. Global uncertainties, unanticipated changes to global oil prices, and weather conditions will continue to pose significant risks to the inflation outlook.

Against this background, the NRBT expects to maintain its current accommodative monetary policy stance over the next six months. The Reserve Bank continues to target the maintenance of an adequate level of foreign reserves and the promotion of low, stable inflation.