The Reserve Bank maintained its current monetary policy stance. This supported the monetary policy objectives of maintaining internal and external monetary stability, promoting financial stability and a sound and efficient financial system and conducting its activities in a manner that supports macroeconomic stability and economic growth. This was by ensuring adequate level of foreign reserves was maintained above 3 – 4 months of import cover, despite annual headline inflation rising to a very high level in February 2017 which was above the reference rate of 5% annually. This reflected the new custom duties and excise taxes introduced in July 2016, rise in global oil and food prices, seasonality in local produce, and shortage of kava-Tonga supply.

The Statistics Department has released its official estimates of real GDP for 2014/15 and its preliminary estimates for 2015/16, indicating a stronger growth. The Reserve Bank’s outlook for a robust domestic economic growth remains for 2016/17 and over the next two financial years 2017/18 to 2018/19. This is expected to be driven by strong growths in financial intermediation, construction, trade and tourism.

In 2016/17, the Reserve Bank estimated a stronger real GDP growth of 3.7% coinciding with a 3.6% growth projected by the IMF Staff Visit in March 2017. This is an upward revision from the estimated 3.6% growth released in the August 2016 MPS, and is mainly driven by anticipated stronger growths in the construction sector and spillover effects on the utilities and the mining & quarry sectors, as well as robust growth in the fisheries sector. Moreover, the number of celebrations and events scheduled for 2016/17 is expected to support the growth in tourism and trade sectors. This includes the LDS Tonga Mission Centennial celebration, school anniversaries particularly for Chanel College Kelana, Tailulu College (Tongatapu) and Mailefihi Siu’ilikutapu College and annual church conferences.

Inflationary pressures continued to rise in February 2017. The annual headline inflation rate increased significantly by 8.9% in February 2017 compared to a 5.1% rise in August 2016, and remained above the Reserve Bank’s reference rate of 5% per annum.

The overall balance of Overseas Exchange Transactions (OET) over the past six months to February 2017 was a surplus of $11.4 million. This was three times lower than the surplus recorded for the past six months to August 2016 of $37.7 million.

The overall surplus in the OET contributed to an increase in the gross official foreign reserves to $377.7 million in February 2017, compared to $366.3 million in August 2016. This was sufficient to cover imports of merchandise goods and services for 7.1 months, well above the Reserve Bank’s minimum range of 3-4 months of imports. In year ended terms, gross official foreign reserves rose by $49.1 million. The lower deficit in the current account balance as a result of higher remittances, higher receipt of foreign aid from donor partners and budgetary support for the Government, contributed to the higher foreign reserves over the past year.

Over the 6 months to February 2017, the banking system remained sound with strong capital and liquidity position maintained, supported by comfortable profitability, and non-performing loans continuing to remain low. Total banks’ lending recorded its highest level in February 2017 at $384.5 million, which increased by $29.3 million (8.2%) from August 2016. Both household and business loans contributed to this growth, supporting economic activities.

Excess liquidity in the banking system remains owing to higher foreign reserves during the six months to February 2017. Broad money continued to rise over the last six months to February 2017 by $19.2 million (3.9%) to $510.2 million. This resulted from a $24.3 million (6.4%) increase in net foreign assets offsetting a $5.1 million (4.5%) decline in net domestic assets. During the last six months, broad money reached a new record high of $512.2 million in December 2016.

The banking system liquidity (reserve money) increased over the last 6 months to February 2017 by $10.8 million (4.0%) to $278.0 million. Throughout the last 6 months, liquidity hit a new level high of $281.3 million in December 2016 which coincided with the new record of broad money stated for the same month. Higher deposits over the past 6 months further supported the growth in reserve money. Total loan to deposit ratios slightly fell in February 2017 to 73.3% from 73.7% in August 2016. This remained below the 80% minimum loan to deposit ratio target which indicated excess liquidity in the banking system remains. Despite the strong growth in the banks’ loan books, this was outweighed by the continuous growth in deposits, which coincided with the higher foreign reserves. This indicates more capacity remains for further lending by the banks, however, the Reserve Bank will continue to closely monitor the lending growth to avoid any overheating in the economy.

Banking system data shows the net credit to Government declined by $28.6 million (43.2%) over the six months to February 2017, driven by rising Government deposits during the period.

Outlook

The Reserve Bank anticipates a strong real GDP growth of 4.8% in 2017/18, an upward revision from the August 2016 MPS estimate of 4.7% and slightly higher than the 4.1% growth estimated by the IMF Staff Visit 2017. This growth is expected to be driven by construction, as Government continues the construction of sports facilities. Additionally, growth in the financial intermediation, transport & communication, trade, fishing and tourism sectors are also expected to contribute to the anticipated overall economic growth.

The Reserve Bank expects the upward inflationary pressure to remain in the near term due to the impact of the increased custom duty and excise tax effective in July 2016. However, the annual headline inflation is forecasted to gradually decline below the reference rate of 5% per annum after August 2017. The uncertainty in movements in global food and oil prices may pose a risk to this outlook. Additionally, the vulnerability of Tonga to natural disasters and adverse weather conditions also poses a risk to the local food prices and consequently the inflation outlook. The Reserve Bank will closely monitor the sources of higher inflation which include assessing the effects of exchange rates, new tax introduced and also the businesses’ profit margins.

The level of foreign reserves is expected to remain at comfortable levels supported by expected higher receipts of remittances, higher export receipts, anticipated government receipt of budget support and grant funds from development partners and this will be partially offset by the projected rise in import payments. The Reserve Bank forecast the level of foreign reserve to increase to $385.4 million in June 2018, which is higher than the IMF Article IV projections of $367.0 million.

The Reserve Bank’s credit growth forecast for 2016/17 still stands at 15% as published in the August 2016 Monetary Policy Statements (MPS). This is higher than the projection by the IMF Article IV of 10.8% for 2016/17. Credit growth is projected to continue to grow in the next six months. The Reserve Bank’s policy measure imposing a requirement on banks’ loans/deposit ratios effective 1st July 2016 should encourage further lending and support the continued growth in credit and broad money. In addition, the Reserve Bank’s initiative to encourage lending to Micro, Small and Medium Enterprises is also expected to contribute to credit growth. At the same time, structural reforms in various sectors as well as other impediments to lending such as the improvement to the land administrative system and a bankruptcy laws would improve the confidence of the banks to lend further in a prudent manner.

Net credit to the Government is anticipated to decline, as a result of expected Government budgetary support and grants receipts.

In light of the above developments and the outlook on the monetary policy, the Reserve Bank will closely monitor the monetary conditions to avoid any overheating in the economy.