Most central banks overseas maintained expansionary monetary policies in the first half of this calendar year, because inflation pressures were moderate. World Gross Domestic Product (GDP) growth was also slower than anticipated in the last Monetary Policy Statement. The International Monetary Fund (IMF) has since lowered its growth figures for calendar 2013, now expecting 2.9 per cent, whereas previously it was expecting 3.3 per cent.

For Tonga, the National Reserve Bank of Tonga (NRBT) estimates that real GDP growth was approximately 0.2 per cent over the 2013 financial year. The figure is lower than the outcome of the previous year, owing mostly to a fall in construction activity. The agricultural industry is estimated to have grown firmly, although its growth is unusually difficult to estimate because the available data on domestic sales look questionable. The outcome for agriculture will have a very important bearing on the overall growth figure.

With economic outcomes subdued, the NRBT implemented expansionary monetary policy, supporting an elevated level of Exchange Settlement Account balances (domestic liquidity). The level of the balances is very high by international standards, even compared with developed countries that are pursuing the most expansionary monetary policies. The balances are significantly in excess of the banks’ actual and precautionary liquidity needs.

Consistent with the elevated levels of Settlement Account balances, and a removal of interest payments on the balances in November 2012, lending rates fell over the six months to September. Growth in bank lending also improved, to become less negative in year ended terms. Still, the contraction in lending would have contributed to Tonga’s slower economic growth outcome.

The balance of foreign exchange transactions was in surplus over the year to September 2013, similar in size to the surplus recorded over the year to March. A narrower current account deficit was offset by an increase in unclassified outflows, with Tonga’s subdued economic growth containing the demand for imports. The key series in the current account have been affected by recent NRBT improvements to the measurement of foreign exchange transactions.

Overall, gross official foreign reserves increased by 4 per cent from the last Monetary Policy Statement, to $254.2 million, or 8.4 months of imports. Reserves are well in excess of the NRBT benchmark of 3 months of imports.

Consumer prices rose by 1.5 per cent over the year ended September 2013. The increase was faster than recorded in last Monetary Policy Statement, but was well below the NRBT reference range of 6 to 8 per cent. The more subdued global growth outcomes over 2013 helped to prevent large increases in world oil and food price increases, thereby limiting local price increases.

Outlook

In calendar 2014 the IMF expects economic growth to increase to 1.6 per cent in real terms. The NRBT expects that Tonga’s growth will also improve in the 2014 financial year, recording real growth above 2 per cent. The expected improvement is driven by an anticipated turnaround in the construction and finance industries, and ongoing growth in the agriculture and distribution industries.

Consistent with Tonga’s better growth outcome, the NRBT expects bank lending growth to lift in the next 12 months, to reach between 0 per cent and 5 per cent in year ended terms. The projection is not as firm as the IMF’s, which is for lending to increase by 7.6 per cent over the year to June 2014.

Foreign reserves are expected to increase throughout the remainder of 2013 and early 2014, on the back of three key factors: remittances will probably rise, albeit at a slower rate; the trade balance is expected to deteriorate slightly, with higher imports being fueled by firmer lending outcomes; and growth in travel receipts will be limited, following the airline-related disruptions to the tourism industry.

For inflation, the NRBT projects the year-ended headline figure to fall to around 0 per cent by July 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. As always, global economic uncertainties and local weather patterns pose risks to the inflation outlook.

With foreign reserves levels expected to remain high and inflation likely to remain low, the NRBT will be 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 of their surplus liquidity levels.