The National Reserve Bank of Tonga’s (NRBT) is tasked with the objectives to maintain internal and external monetary stability, promote financial stability and a sound and efficient financial system, and to conduct its activities in a manner that supports macroeconomic stability and promote economic growth by ensuring adequate level of foreign reserves and low and stable inflation are maintained. In the past six months to February 2016, these objectives were observed.

The economic growth prospects look promising. The NRBT projected strong growth for real gross domestic product (GDP) over the three consecutive financial years 2014/15 through to 2016/17. Growth is expected to be driven by the construction, trade and tourism sectors. The Department of Statistics has yet to release its official estimates for 2014/15 financial year. The NRBT estimated Tonga’s economy to have grown strongly in 2014/15. Estimates were slightly revised upwards from the previously published projection in the August 2015 Monetary Policy Statement (MPS) due to new data received from the Ministry of Agriculture, Food, Forestry and Fisheries (MAFFF) for the fisheries sector. The NRBT expected the economy to have expanded by 3.3% in 2015/16, consistent with the International Monetary Fund (IMF) Article IV projection of 3.1% growth.

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

annual deflation was recorded almost throughout the entire year. On an annual basis, February 2016 recorded a deflation of 0.3% compared with a deflation of 1.2% in February 2015 which is well below the NRBT’s reference range of 6-8%. The balance of overseas exchange transactions (OET), which is equivalent to the net change in the foreign reserves, deteriorated over the past six months to February 2016 to a surplus of $17.6 million. This is 40.3% lower than the $29.5 million surplus in the past six months to August 2015. This was due to a higher deficit in the current account at the end of the six months to February 2016, compared to a surplus in the past six months to August 2015. This was a result of increasing import payments over the last six months.

The level of foreign reserves continued to rise and remained above 3-4 months of import cover bolstered by higher export proceeds, travel receipts, and remittances, as well as the receipt of foreign aid from donor partners including budgetary support for the government. In February 2016, foreign reserves reached another record high of $328.5 million, sufficient to cover 9.3 months of imports, well above the NRBT’s minimum range of 3-4 months.

The financial system remained sound over the 6 months to February 2016 as the banking system continued to be profitable and maintained strong capital and liquidity positions. Broad money increased to its highest record of $456.5 million compared to $424.2 million in August 2015. Banking system liquidity also grew by 6.4% to a new record high of $177.9 million. Banks’ weighted average interest rate spread continued to narrow in February 2016 to 5.84% from 5.98% in August 2015. Total bank lending rose over the 6 months to February 2016 by 7.1% to its highest level of $331.9 million compared to a 4.2% growth in the 6 months to August 2015.

The banking system data showed the net credit to government fell by 3.0% over the six months to February 2016, compared to an increase of about 11.0% over the six months to August 2015.

The NRBT anticipates economic growth to slightly ease to 1.9% in 2016/17, which is still well above the average growth of 1.4% of the past ten years for Tonga. This follows after a period of strong growth in the previous years. Inflationary pressure is expected to remain low in the remaining months of 2015/16, and to record an annual deflation of 0.6% in June 2016 then increase to a peak of 3.8% annual inflation at the end of 2016.

The level of foreign reserves is expected to remain comfortably above the minimum range to June 2017. The deficit in the trade balance is expected to narrow with higher imports being fuelled by anticipated higher export receipts and firmer lending outcomes. Remittances and travel receipts are expected to remain high due to upcoming festivities.

Credit growth is forecasted to continue and a growth of about 14.4% to be recorded at the end of the 2015/16 and 11% in 2016/17. This coincides with the IMF Article IV projection of 15.5% growth for 2015/16 and 10.8% for 2016/17. The NRBT’s proposed policy measures that are currently being discussed with the banks, such as a target on banks’ loans/deposit ratios to encourage further lending, should also support the anticipated continued growth in credit and broad money. At the same time, it is important for the structural reforms in different sectors as well as other impediments to lending such as the improvement to the land administrative system and the bankruptcy laws to improve the confidence of the banks to lend further in a prudent manner. Net credit to the government is also expected to increase, coinciding with the higher liquidity within the banking system and broad money. However, this is also subject to the proposed expenditure in the financial year 2016/17 budget estimate, which is due to be released in June 2016. NRBT will closely monitor the implication of the fiscal policy measures on the monetary policy objectives.

In light of recent developments and the outlook on the monetary policy targets, the current accommodative monetary policy stance is therefore considered appropriate in the medium term. However, as the 2016 IMF Article IV mission had recommended, the NRBT will remain vigilant and closely monitor early signs of vulnerabilities. At the same time, the NRBT is reviewing and imposing new policies to enhance its role in promoting macroeconomic and financial stability.