Throughout the last six months to February 2019, the Reserve Bank maintained its current accommodative monetary policy stance. This supported meeting the monetary policy objectives by ensuring an adequate level of foreign reserves was maintained above 3 months of import cover, and the exchange rate remained competitive. Inflationary pressure eased as the inflation rate fell below the reference rate of 5% per annum in February 2019. Financial stability was maintained with no signs of overheating, despite the strong credit growth over the year, while excess liquidity still remains in the banking system.

Preliminary figures released from the Tonga Statistics Department shows Real GDP growth of 0.2% for 2017/18 following very strong growth of 5.4% in 2016/17. This is lower than the 3.1% forecasted by the Reserve Bank, but was close to the IMF’s forecast 0.1%. The slow down in 2017/18 was mainly driven by negative growths in the construction, fisheries, and utility sector. Other sectors recorded slower growth compared to the previous year except for the Mining & Quarrying sector, and the Ownership of dwellings.

The annual headline inflation has returned below the Reserve Bank’s reference rate of 5% since December 2018. In February 2019 it has declined further to 3.2% mostly driven by lower import prices of food products and oil. On the other hand, domestic prices increased by 8.5% over the year due to rising prices of local food items and tobacco. However, this was offset by the decline in import prices.

Balance of the Overseas Exchange Transactions (OET) was at a $1.5 million deficit, over the six months to February 2019, compared to a $27.0 million surplus in the six months to August 2018. This deficit is underpinned by the widening of the current account deficit due to growing import payments and lower transfer receipts. Consequently, the official foreign reserves declined to $473.5 million in February 2019 from $475.0 million in August 2018.

The official foreign reserves were sufficient to cover 8.0 months of import of merchandise goods and services in February 2019, which is still above the Reserve Bank’s minimum level of 3 months of imports cover. In year ended terms, gross official foreign reserves rose by $25.5 million, corresponding to higher receipts of remittance, foreign aid from donor partners and budgetary support for the Government. The Reserve Bank implemented the Foreign Exchange Control Act which came into effect in November 2018 and issued its Exchange Control Directive to improve it’s ability to better manage, and to maintain an adequate level of foreign reserves.

The banking system continued to remain sound supported by strong capital position, adequate profitability, high liquidity, and low levels of non-performing loans. Over the six months to February 2019, the total banks’ lending continued to rise to a new record high, whereas deposits slightly declined. The expansion in lending was mainly for businesses in the transport, wholesale & retail, manufacturing and construction sectors. This reflected growth in the private sector, business confidence and on-going construction of infrastructure projects. The weighted average interest rate spread also widened as lending rates increase while deposit rates declined.

Liquidity in the banking system (reserve money) has declined to $320.6 million in February 2019 after reaching a record high of $334.2 million in August 2018. This is attributed mostly to lower deposits by the commercial banks to the Reserve Banks vault coupled with the lower currency in circulation. The Reserve Bank maintained its policy rate at 0%, and the Statutory Reserves Deposit Ratio at 10%, while encouraging commercial banks to utilize the excess liquidity for further lending. Broad Money also fell to $589.0 million as a result of lower net foreign assets and net domestic assets. The lower net foreign assets over the past 6 months is in line with the decline in foreign reserves, whereas decreasing net credit to Government led to the lower net domestic asset. Meanwhile, banks’ total loans to deposit ratio continued to edge up to 76% but still remained below the 80% minimum loan to deposit ratio, indicating there is still capacity for further lending by the banks to further support economic growth.

Government deposits rose by 14.3% over the past six months to February 2019, resulting in the lower net credit to Government. Higher government revenue collection combined with receipts of budgetary support, grants, and cyclone relief funds from development partners supported the higher government deposits.

Outlook

Due to the delays in the implementation of major Government projects and the updated statistics received during the past six months, the Reserve Bank has revised its previous forecast of 4.5% Real GDP growth for the year 2018/19, down to 3.4%. The anticipated growth is supported by projected growths from various sectors such as the agricultural, construction, trade, utilities, mining & quarrying, transport & communication, and ownership of dwellings sector. The impact of TC Gita on the primary sector is expected to wear off towards the end of the financial year, whereas construction and infrastructural projects are expected to boost the secondary sector. Active trading and further development to the transport and tourism sector are also expected to strengthen the tertiary sector.

As previously anticipated, the inflation rate has fallen below the Reserve Bank’s reference rate of 5% in 2019, and it is expected to remain below the reference rate for the remainder of 2019. Nevertheless, Tonga’s vulnerability to natural disasters and the developments in global food and oil prices pose a risk to this expectation. The Reserve Bank will closely monitor the sources of higher inflation, which include assessing the impact of the rate of exchange of the paánga against the other currencies, and new Government tax introduced.
Despite the slight decline in the level of foreign reserves, the Reserve Bank still expect it to remain at comfortable levels well above the minimum of 3 months of imports by the end of 2018/19. This forecast is supported by expected receipts of budgetary support and grant funds from development partners and expected higher receipts of remittances. This will be partially offset by the projected rise in imports and public debt repayment overseas.

The Reserve Bank still projects a credit growth of 13% for 2018/19. Seasonal festivals and cultural obligations, coupled with the ongoing business investments will increase demand for credit and continue to support credit growth. The excess liquidity in the banking system still remains indicating available capacity for further lending by banks. The Reserve Bank will continue to remain vigilant and closely monitor the credit growth and broad money movements for any early signs of overheating in the economy. Non-performing loans are also expected to remain at low levels.

Net credit to the Government is also anticipated to decrease as a result of expected Government budgetary support and Government grants receipts, as well as improved Government revenue collection. Meanwhile, the Reserve Bank will closely monitor the implication of the fiscal policy measures on the monetary policy objectives.

Given the recent developments and the outlook on the monetary policy targets, the Reserve Bank considers its current accommodative monetary policy stance to be appropriate in the medium term. Therefore, the Reserve Bank will maintain its current 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, the recovery from TC Gita, and strengthen the monetary policy transmission mechanism. Furthermore, the Reserve Bank will continue to monitor developments in the domestic and global economy closely, and update its monetary policy setting to maintain internal and external monetary stability and to promote a sound and efficient financial system that supports macroeconomic stability and economic growth.