World output grew by 3.0 per cent in calendar year 2013, slightly faster than the expectation published in the September 2013 Monetary Policy Statement. Growth strengthened in the second half, particularly in the advanced economies.

For Tonga, the official national accounts data for financial year 2013 are still unavailable. The NRBT estimates that real economic growth slowed to 0.2 per cent, owing mostly to a slowdown in construction activity. The estimate is the same as in the NRBT’s September 2013 Monetary Policy Statement, although the figures for some of the individual sectors have changed. Activity appears to have lifted a little in the first half of financial year 2014.

With local economic activity still quite weak, and a lot of excess capacity in the economy, the NRBT has set all of its conventional monetary policy tools at their expansionary limits. As such, Interest rates on each of the key bank lending categories fell by between 20 and 40 basis points over the six months to February 2014 and bank lending growth increased. In year-ended terms, bank lending is now growing at the fastest rate recorded since early 2009.

Consumer prices rose over the 12 months to February 2014 by 4.7 per cent. The increase was the fastest since September 2011 but below the NRBT reference range of 6 to 8 per cent. Much of the increase reflects a sharp rise in the prices of domestically produced vegetables, some of which have coped poorly with the unusually hot and wet weather conditions prevailing recently. The level of economic activity is less relevant for the rate of inflation in Tonga than is the case in larger countries.

The balance of foreign exchange transactions was in surplus over the year to February 2014, wider than the surplus recorded over the year to August 2013. The widening reflected a higher capital account surplus and a lower current account deficit, with Tonga’s subdued economic outcomes containing the demand for imports. As such, gross official foreign reserves were $281.1 million as at the end of February 2014. The level is equivalent to a record 9.4 months of import cover, which is the highest on record and well above the NRBT benchmark of 3 months of imports.

Outlook

The IMF expects global growth to strengthen to 3.6 per cent over calendar year 2014. In 2015 it is expecting growth of 3.9 per cent. The risks to the outlook are still tilted to the downside, albeit less so than over recent years.

In Tonga, the NRBT expects real GDP growth of 2 per cent in financial year 2014. Improved economic conditions in trading partners will provide some support, but much of the anticipated improvement comes from a projected rebound in the construction. A lift in bank lending growth will also stimulate activity, with positive spillovers to several sectors. The NRBT estimates that growth would be 1.1 percentage points higher if not for the destruction in Ha’apai caused by Cyclone Ian.

In financial year 2015 the NRBT is anticipating that growth in real GDP will lift to around 3.2 per cent. Much of the growth reflects an output recovery in the cyclone-affected areas of Ha’apai, especially in the form of manufacturing, agriculture, and construction. Had it not been for Cyclone Ian the NRBT would have forecast growth of around 2.1 per cent.

The increase in bank lending is expected to reach 10 per cent over the current financial year, on the back of imminent draw downs of some large loan commitments, an expected fall in interest rates, and a general improvement in economic conditions. Similar growth is expected in financial year 2015, perhaps a little softer.

The NRBT projects headline inflation will fall to around 2.5 per cent in June, before falling to 0 per cent at the end of 2014. The projected fall stems mainly from an expectation that world food and oil prices will fall over the next 12 months. The anticipated pick-up in local economic growth is unlikely to have a large offsetting effect. Global economic uncertainties and local weather patterns pose the most important risks to the inflation outlook.

The level of foreign reserves is forecast to increase over the remainder of financial year 2014 and again over financial year 2015. Underlying the projected increase is a balance of factors, including expectations of remittances being little changed, the trade balance deteriorating slightly, a commencement of principal repayments of a large government loan from a bank overseas, and large inflows of official grants to assist with the Ha’apai reconstruction efforts. Uncertainty surrounding the size and timing of grant inflows poses the most significant risk to the outlook. The Ministry of Finance is also involved in negotiations regarding deferral of some of its principal debt repayments. However, even in a worst case scenario, the level of foreign reserves will remain comfortably above the NRBT benchmark.

As foreign reserves levels are expected to remain high, and the economy is likely to be operating with excess capacity for some time, the NRBT expects to continue implementing a monetary policy setting that is as supportive as possible for economic activity over the near term. The NRBT will continue its monthly dialogue with the banks on ways to encourage lending.