The coronavirus pandemic (COVID-19) has shocked the world at an unprecedented speed and scale. It is first and foremost a health crisis, with many human lives being lost across many countries. It has also evolved quickly to becoming an economic crisis driving the global economy into a recession worse than the Great Depression. Financial markets have already felt a huge impact within the first few months of 2020, and could become a financial crisis should the economic fallouts intensifies.

Tonga is one of the few countries that has not yet contracted the virus, and it has quickly responded with measures to ensure it remains that way given the limited capacity of its health system. The Ministry of Health has taken the lead in recommending containment and precautionary measures to be implemented in the country. This led to the closing of the border from international travel since March 2020 and observing a 2 weeks national lockdown in April. Tonga continues to suffer from natural disasters such as Tropical Cyclone (TC) Harold in April 2020, leaving damages in its aftermath to businesses, dwellings, infrastructure, and agriculture.

Over the six months to February 2020, the Reserve Bank has maintained its current accommodative monetary policy stance to support its monetary policy objectives of maintaining internal and external stability, and promoting a sound and stable financial system. This monetary stance was also appropriate to support macroeconomic growth and stability given the negative impacts of COVID-19 and TC Harold on the economy.

The Tonga Statistics Department has released its preliminary real GDP growth for 2018/19 of 0.7%, a slight improvement from the 0.3% growth in 2017/18 reflecting a slow recovery from TC Gita. However, this is lower than the 3.2% growth forecasted by the Reserve Bank in the August 2019 MPS, reflecting a weaker than expected outturn for the secondary and tertiary sector, owing mostly to the deferral in the implementation of large infrastructure projects. The pace of domestic economic activity during these past six months was somewhat slower compared to the same period in the previous year. The measles outbreak in October and November 2019 prompted the cancellation of many of the end of year functions and celebrations contributing to the slower performances in domestic activities.

The annual headline inflation has been relatively low over the past six months, averaging at 0.7% over the year to February 2020. The annual headline inflation has remained below the Reserve Bank’s reference rate of 5% since December 2018. Despite the gradual rise in import prices, the declining domestic prices have anchored inflation rates near zero during the review period.

Gross official foreign reserves has declined over the past six months by $12.0 million to $479.8 million, corresponding to lower foreign currency receipts. Nonetheless, official foreign reserves is still at adequate levels, sufficient to cover 7.4 months of import of merchandise goods and services1 which is above the Reserve Bank’s minimum level of 3 months of import cover.

Monetary conditions remained sound and stable since the last review in August 2019, supported by strong capital position, adequate profitability, high liquidity, and low levels of non-performing loans. The Reserve Bank maintained its policy rate at 0%, the Statutory Reserves Deposit Ratio at 10%, and the minimum loans to deposit ratio at 80% to encourage commercial banks to utilize the excess liquidity for further lending. Broad money fell by $10.4 million to $590.1 million over the six months to February 2020, while liquidity (reserve money) also declined by $13.4 million to $297.9 million. The lower broad money corresponds to the decline in net foreign assets, while the decline in liquidity was mostly driven by lower currency in circulation and commercial banks’ exchange settlement account balances.

Commercial Banks’ lending continued to rise since August 2019 by 0.6% ($3.2 million) to $499.7 million, as both business and household lending grew. It is noted that this is a slower growth compared to the 2.7% growth over the six months to August 2019 coinciding with the slower pace of economic activities. Deposits, on the other hand, declined by $21.0 million. As a result, the banks’ total loans to deposit ratio rose to 84.1%, from 79.0% in August 2019. This is also above the Reserve Bank’s threshold of 80% minimum loan to deposit ratio. The weighted average interest rate spread continues to narrow during the six months as lending rates declined coupled with higher deposit rates.

Government deposits decreased by 3.4% over the past six months to February 2020 due to the payments of loan interests to the EXIM Bank of China. Accordingly, net credit to the Government rose by 3.9%. The continuing inflow of budgetary support, grants, and cyclone relief funds from development partners in addition to improved revenue collections continues to support the fiscal position.

Outlook

On the outlook, the Reserve Bank envisions a significant downturn for the Tongan economy due to the negative impacts of COVID-19 on tourism, travel, transport, and the trading sectors. Containment and precautionary measures such as national lockdown, social distancing, and curfews affect multiple sectors of the economy through limited operations and weak consumer demand. Some tourism businesses have come to a complete standstill while others are presented with a significant reduction in operations forcing some businesses to lay off its employees. The impacts of TC Harold is expected to exacerbate an already distressed economy. The Reserve Bank projects a contraction in Tonga’s real GDP growth of -6.3% for 2019/20, and -2.7% for 2020/21 contrast to its previous forecast of positive growths in the August 2019 MPS.

Inflation rate is projected to gradually increase driven by higher import prices, yet remain below the 5% reference rate up to June 2021 as oil prices are projected to remain low offsetting the expected rises in other imported goods due to supply chain disruptions and additional surcharges for COVID-19.

Foreign reserves is still expected to remain at comfortable levels above the minimum of 3 months of import cover throughout 2020. The inflow of additional budget support, grants, and relief funds from development partners to assist with preparations for COVID-19 and TC Harold is expected to sustain foreign reserves at an adequate level. At the same time, it may offset a likely decline in remittances and travel receipts due to weaker growths experienced by our major remitting countries.

Credit growth is anticipated to be subdued in 2019/20 as borrowers remain cautious of the uncertainty on when will business returns back to normal after the pandemic. There is still excess liquidity in the banking system indicating a further capacity for lending. Meanwhile, commercial banks have taken initiatives to assist their customers who are affected by these events through moratoriums, deferrals of interests, and loan restructures. Nonetheless, non-performing loans are still expected to be at low levels through maintaining standards on monitoring asset quality and prudent lending practices.

Fiscal policy is likely to be expansionary over the medium term as the Government takes action to combat COVID-19, mitigate its economic impacts on the country, and provide relief for those affected by TC Harold. However, because of these crises, the inflow of budgetary support and relief funds from donor partners is expected to be higher. The Reserve Bank will closely monitor the implications of the fiscal policy measures on its monetary policy objectives.

Nevertheless, COVID-19 is unlike any crisis the world has ever seen. Forecasting the full impact and magnitude of the pandemic is like navigating on uncharted waters. There is profound uncertainty on how deep and how long the scarring effects of the pandemic will have on the economy, especially with no cure being found yet. This is a downside risk to the forecast, in addition to Tonga’s vulnerability to global shocks and natural disasters. The Reserve Bank will follow these developments closely and will revise its forecast regularly to assist with its monetary policy decisions.

Given the recent developments and outlook, 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 to support macroeconomic growth. In March 2020, the Reserve Bank introduced additional monetary policy measures to support commercial banks’ efforts in assisting its customers who are affected by COVID-19 and TC Harold. It also provided financial support to the Government in its effort to provide financial support to affected sectors of the economy. The Reserve Bank remains vigilant and alert by closely monitoring both economic and financial developments, and stands ready to provide corrective measures where necessary to achieve its monetary policy objectives.