The Reserve Bank’s monetary policy remained accommodative in the past six months to support the economic recovery as foreign reserves were at high levels and price pressures moderate. Foreign exchange reserves are at record levels, underpinned by buoyant inflow of donor funding.

The National Reserve Bank of Tonga’s (NRBT) primary monetary policy objectives of maintaining an adequate level of foreign reserves and promoting low and stable inflation were achieved. In the past six months, the level of foreign reserves remained well above 8 months of import cover supported by foreign aid inflows. Consequently, liquidity in the banking system continued to remain at a high level. However, banks’ credit growth to the private sector continued to contract due to tight lending conditions, weak domestic demand and slow economic recovery.

The high receipts of government aid funds from Tonga’s development partners, more than offset the outflow of official capital and import payments during the past six months. As a result, at the end of March 2012, the official foreign reserves reached a record high of $239.2 million, equivalent to 9.1 months of imports compared with $208.1 million (7.8 months of imports) at the end of September 2011.

Private sector credit growth slowed down further reflecting the one off settlement of large private loans, the competition from the Government Retirement Fund loan scheme, the lending by micro finance companies, the slow economic recovery and the write off of bad loans. The banks’ tight credit criteria continued to affect private sector credit growth, at the same time, domestic demand for credit has been suppressed by the continuing decline in private remittances and the decline in exports over the past 4 years.

The annual headline inflation declined in the past six months to a low of 1.8 percent in the year ended March 2012. The easing in the past six months was largely underpinned by the decline in the prices of local & imported food and to a lesser extent the slower growth in the price of imported fuel.

Economic growth in advanced economies is picking up slowly except for the Euro area. The US economy expanded at 3 per cent in the December quarter of 2011 and East Asian economies are picking up after the effects of natural disasters of 2011. Economic growth in China has slowed to over 8 per cent, reflecting tighter domestic policies. Output growth in Australia has been below trend over the past year due to softer growth in non mining sectors while the New Zealand economy has performed relatively well over the past six months underpinned by increase in household and retail spending during the second half of 2011. These international developments affected Tonga’s economic activity mainly through the flow of private remittances, tourism, oil and food prices, inflation and the exchange rate movements.

Outlook

Domestic economic activity is expected to be supported by donor-funded construction and infrastructure projects, tourism as well as agricultural activity. The anticipated improvement in squash and watermelon exports should provide support to activity in the agriculture sector in the next six months. However, the recovery in the domestic economy will continue to be at a slow pace based on the projection that stagnant remittances will suppress domestic demand. The high unemployment rate in the United States and the slower growth in Australia will affect remittances and tourism but the higher economic growth expected for New Zealand could support remittances and tourism inflow to Tonga.

Foreign reserves are expected to remain at high levels in the next six months, above 7.0 months of import cover. This is mainly due to the expected receipts of official aid funds from Tonga’s development partners, which will more than offset the repayment of official foreign debt and other foreign currency payments. The anticipated improvement in agricultural exports will support the foreign reserves.

Credit growth is expected to slowly pick up in the next six months mainly due to new loans expected to be made to public enterprises. Liquidity in the banking system is expected to remain high from the receipts of aid funds from Tonga’s development partners.

Despite the volatility in world oil and food prices, inflation is expected to remain below the Reserve Bank’s benchmark of 6 to 8 percent in the next six months. The uncertainty in the euro area will have flow on effects to the rest of the world through trade, financial and confidence channels. These international developments will affect the level of commodity prices and the value of the Pa’anga which will have an impact on imported inflation.

Against this background, the current accommodative monetary policy stance will be maintained in the next six months. The Reserve Bank will continue to target maintaining the country’s foreign reserves position at an adequate level, and promoting low inflation, mindful of the risks to the outlook on the global economic and financial situation and their impact on the domestic economy. The Reserve Bank will continue to closely monitor the country’s economic and financial conditions in order to promote a sound and efficient financial system.