The Reserve Bank’s monetary policy objectives were observed during the past six months to February 2018 and for that reason the Reserve Bank maintained its current monetary policy stance. Inflationary pressure eased in February 2018, foreign reserves remained at comfortable levels above the minimum range of 3 – 4 months of import cover and exchange rates remained competitive. The stability of the financial system was maintained with no signs of overheating despite the strong credit growth over the year and excess liquidity remains in the financial system. Overall, the domestic economy experienced favorable growth as projected.

The Statistics Department has released its preliminary estimates of Real Gross Domestic Product (GDP) growth for 2016/17 of 5.0%. This is the highest growth for Tonga since 1998/99 and is also the fourth year of consecutive growth. This strong growth was largely driven by the industrial and services sectors and it is much higher than the growth forecasted by the Reserve Bank and the IMF of 3.7% and 3.6% respectively.

Inflationary pressures eased in February 2018, falling below the Reserve Bank’s 5% reference rate. This was the lowest headline inflation since it started rising in July 2016 when the new custom duties and excise taxes were introduced. Additionally, the rise in global oil and food prices, seasonality of local food, and shortage of kava-Tonga supply drove the annual headline inflation to high level.

The overall Overseas Exchange Transactions (OET) balance for the past six months to February 2018 recorded a surplus of $43.0 million, leading to the increase in the official foreign reserves from $405.0 million to $448.0 million. This surplus was 57.0% ($15.6 million) higher than the surplus recorded for the last six months to August 2017 due to surpluses in all the three accounts with the highest contribution from the capital account.

The level of official foreign reserves at the end of February 2018 was sufficient to cover 8.1 months of import of merchandise goods and services, which remained above the Reserve Bank’s minimum range of 3-4 months of import. In year ended terms, the gross official foreign reserves rose by $70.3 million. The increase over the year was due mainly to higher remittance receipts, higher receipts of foreign aid from donor partners and budgetary support for the Government.

The banking system continued to remain sound over the 6 months to February 2018. Banks maintained a strong capital position which was supported by their comfortable profitability, high liquidity, and low level of non-performing loans. Total lending maintained consistent growth and reached a new record high in February 2018. Deposits climbed to new heights also which coincided with the high level of foreign reserves. Meanwhile, the weighted average interest rate spread widened over the period.

Liquidity in the banking system (reserve money) continued to increase over the last 6 months to February 2018 by $14.8 million (5.2%) to $297.6 million which was supported by the increase in the Statutory Required Deposit (SRD) requirement that was effective in July 2017. During the past 6 months, liquidity reached a new high level of $300.7 million in November 2017. Higher deposits over the past 6 months further supported the growth in reserve money. Broad money rose over the last 6 months to February 2018 by $5.9 million (1.1%) to $558.2 million compared to $552.3 million in August 2017. This was driven by net foreign assets which increased by $39.1 million offsetting a $33.1 million decline in net domestic assets. Higher foreign reserves (with contribution from receipt of Tropical Cyclone (TC) Gita relief funds in February 2018) continued to drive the rise in net foreign assets while the increase in deposits drove the fall in net domestic assets. Broad money reached a new record high of $560.6 million in December 2017. This ratio continued to remain below the 80% minimum requirement for loan to deposit ratio which indicates excess liquidity in the banking system remains and that there is capacity for further lending by the banks.

Banking system data shows the net credit to government continued to decline by $53.2 million (47.5%) over the 6 months to February 2018, compared to a $17.2 million (18.2%) decline in the 6 months to August 2017. This stemmed from the increase in government deposits during the past 6 months to February 2018.

The Reserve Bank continued its financial inclusion initiatives to promote access to financial services and provide further protection to the consumers through regulating the non-bank financial institutions. Three legislations were passed by Parliament for the regulation of microfinance institutions, money lenders and foreign exchange dealers and await royal assent.

Outlook

Tonga’s economic performance for 2017/18 remain positive despite the devastation caused by TC Gita in February 2018. The outlook for the real GDP growth for 2017/18 has been revised downward from 4.0% to 3.1% due to the lowering of the projected growth in the trade, agricultural, utility, fisheries, transport & communication and ownership of dwellings sectors.

The Reserve Bank expects the inflationary pressure to remain in the near term, due to the impact of TC Gita on the domestic food supply, and to fall below the Reserve Bank’s inflation reference rate of 5% per annum at the end of 2018. The movements in global food and oil prices may pose a risk to this outlook. Additionally, the vulnerability of Tonga to natural disasters 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.

he level of foreign reserves is expected to remain at comfortable levels well above the minimum range of 3‐4 months of import cover supported by expected higher receipts of remittances and foreign aid. This will be partially offset by the projected rise in imports and the commencement of the Government’s principal loan repayment to the EXIM Bank of China.

The Reserve Bank’s credit growth forecast for 2017/18 was revised upwards to 16% from 15% as published in the August 2017 Monetary Policy Statements (MPS), and is lower than the IMF Article IV projection of 16.6% for 2017/18. The banks cyclone relief packages are expected to support further credit growth. In addition, the excess liquidity in the banking system remains indicating there is capacity for further lending by banks hence supporting banks’ efforts to support customers borrowing to recover from the cyclone. The Reserve Bank will continue to closely monitor the credit growth and broad money developments to ensure financial and macroeconomic stability are maintained and that there is no overheating in the economy. Non-performing loans is also likely to decline in the near future.

Net credit to the government is also expected to fall due to anticipated budgetary support and government grants receipts, as well as improved government revenue collection. However, this will be partially offset by the commencement of the Government’s repayments of loan principal amount to EXIM Bank of China and the projected expenditure in the government’s 2018/19 budget statement, which is due to be released in June 2018. The Reserve Bank will closely monitor the implication of the fiscal policy measures on the monetary policy objectives.

In light of the above developments and the outlook on the monetary policy targets, the current monetary policy stance is considered appropriate in the medium term. Therefore, the Reserve Bank will maintain its monetary policy measures in the medium term in order to encourage the utilisation of the excess liquidity in the banking system to increase lending, particularly to the growth sectors, in order to support domestic economic growth and recovery from TC Gita, and strengthen the monetary policy transmission mechanism. Furthermore, the Reserve Bank will continue to closely monitor developments in the domestic and global economy, and update its monetary policy setting to maintain internal and external monetary stability, and to promote a sound and efficient financial system in order to support macroeconomic stability and economic growth.