The outlook for the Tongan economy remains positive. Real Gross Domestic Product (GDP) is expected to record growth of 2.2% in 2014/15 supported by positive spillover effects from the declining global oil prices and low inflation. This is a downward revision from an estimate of 2.9% in the August 2014 Monetary Policy Statement, which largely reflects an unexpected contraction in the agricultural sector due to adverse weather conditions and delays to large construction projects scheduled for the year. Consumer prices recorded the first deflation rate since May 2013 of -1.1% over the 12 months to February 2015.

Gross official foreign reserves have increased over the past six months, reaching a new record high of $293.6 million at the end of December 2014 before declining to $281.3 million at the end of February 2015. This is in line with a surplus of $0.2 million in the balance of overseas exchange transactions (OET) over the year to February 2015, which is much lower than the surplus in the last publication. The lower surplus reflected a higher current account deficit and a lower capital account surplus. Remittances, the major source of overseas exchange earnings, increased by 10.1% over the past six months to February 2015.

Despite the continued concern with the overall quality of the banks’ loans, the banking system continued to be profitable, maintaining strong liquidity and capital positions. Credit growth continued to rise, reaching its highest level since February 2011, whilst maintaining narrow interest rate spreads. Broad money rose by 1.7% over the past six months to February 2015 driven by an increase in net domestic assets.

Over the six months to February 2015, net credit to government fell by more than 5.0% compared to an increase of about 12% over the six months to August 2014. The outcome reflects an increase in government deposits more than offsetting a slight increase in banks’ holdings of government bonds.

Outlook

Looking forward, the NRBT anticipates stronger growth for 2015/16 of 3.2%, driven by a rebound in primary activities, stronger financial intermediation and expected improvements in the tourism and construction sectors. Headline inflation will continue to remain negative until the end of this calendar year.

The outlook for the gross official foreign reserves is expected to remain high over the remainder of the 2015 and 2016 financial year, well above the NRBT minimum range of 3 – 4 months of imports coverage. Remittances are anticipated to rise on the back of upcoming festivities such as the coronation and church conferences, although the growth will be slow. However, a proposed 1% levy on all private transfer receipts and payments poses a risk to the outlook on the foreign reserves as this will affect the country’s overall balance of payments position.

Broad money is expected to increase as credit growth is likely to grow by over 10%, with anticipated increases in net credit to government in the next six months. Liquidity in the banking system is also projected to remain high while interest rate spread is expected to remain low. Monetary conditions may be affected with the takeover of Westpac Bank of Tonga by Bank of South Pacific; the NRBT includes non-banks within its regulatory framework; and the NRBT’s commitment to promoting financial inclusion. However, challenges to financial stability remain, particularly due to a recent court decision which may undermine the banks’ ability to recover non-performing loans. This may also discourage credit extension by the banks.

The fiscal position has improved according to the IMF 2015 Article IV report, supported by large grant inflows but spending pressures for government remains high in the near term. The NRBT will assess the impact of the Government’s 2015/16 fiscal budget on the monetary policy targets.

In light of the recent developments and the outlook on the monetary policy targets, the current accommodative monetary policy setting is considered appropriate in the next six months. Nevertheless, the NRBT will continue to closely monitor the country’s economic developments and financial conditions to maintain internal and external monetary stability, promote financial stability and a sound and efficient financial system to support macroeconomic stability and economic growth.