Catalog

	Table of Contents
p. 53 of 68 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Central Asia The Pacific Cook Islands Fiji Islands Kiribati Republic of the Marshall Islands Federated States of Micronesia Nauru Papua New Guinea Samoa Solomon Islands Democratic Republic of Timor-Leste Tonga Tuvalu Vanuatu III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : II. Economic Trends and Prospects in Developing Asia

---

Tonga

The macroeconomic situation remained difficult in 2002, with fairly weak growth, a surge in inflation, and a deterioration in the fiscal position. However, the squash season was exceptional, remittances rose significantly, and the Government made progress in implementing its comprehensive Economic and Public Sector Reform Program. Prospects are for economic performance to improve somewhat over the next 2 years.

Macroeconomic Assessment

The economy grew by only 1.6% in FY2002 (ended 30 June 2002), the second consecutive year of poor performance. The squash season was exceptional, though production of root crops was weak, a reflection of the damage inflicted by cyclone Waka. Fishing was hampered both by poor weather and by lack of transport capacity, though construction and mining expanded strongly due to infrastructure building related to cyclone damage. The tertiary sector grew by a meager 0.6%, reflecting a decline in the commerce, restaurants, and hotel subsector and low growth in government services. After an initial fall due to reduction in air access to and from the US and the cyclone, tourism recovered in the second half of the calendar year 2002, leading to a 2% rise over the preceding year.

Employment mirrored the weakness of the economy. Although around 2,000 young people leave school to look for work every year, only about 500 find jobs, mostly in the formal sector, and only a few can emigrate. Thus, the number of educated unemployed and underemployed is growing. This is contributing to a rise in crime and other social problems.

Inflation rose steeply to 10.4% in FY2002, up from 6.9% in the previous year (Figure 2.33). Inflationary pressures were the outcome of a combination of factors, including local food shortages, higher wages, and the weakening of the currency by 20% in nominal effective terms (against a currency basket including the Australian, New Zealand, and US dollars, and the Japanese yen) since mid-2000.

The official budget is considered to have ended in a deficit of 1.5% of GDP in FY2002, or higher than the expected 0.6% of GDP. Total revenues (including grants) increased by 14.5%, driven largely by a 28.8% jump in trade taxes, while total expenditures rose by 15.7%, due to a sharp increase in the wage bill and expenditures on other goods and services. Subsidies for public enterprises also increased sharply, from 0.2% to 4.8% of total expenditures in FY2001 and FY2002, respectively. Current expenditures were slightly in excess of current revenues. Capital expenditures were a bit higher than in FY2001, amounting to only 3.5% of total government expenditures. The recent strain on the fiscal position reflects the continuing impact of 2001's 20% increase in public wages and the increase in subsidies to public enterprises.

In response to rising inflation and pressure on the balance of payments, the authorities tightened monetary policy in FY2002, with continued reliance on credit ceilings as the main instrument, as weakness in the central bank's balance sheet precluded the issue of short-term notes. Reflecting this tightening, growth of broad money slowed to 7.9% from the very rapid growth of 26.5% in FY2001. Expansion of domestic credit also decelerated, to 8.0%, but private sector credit growth remained strong at 14.6%. Net credit to government increased rapidly in the first half of the fiscal year; however, by June 2002, the Government had become a net lender to the banking system as it deposited the first tranche of the Economic Public Sector Reform Program (EPSRP) loan from ADB. The weighted average deposit rate offered by commercial banks declined marginally to 4.6% in June 2002 and was negative in real terms. The base lending rate was stable at 9.0%, and has been unchanged since the mid-1990s.

Exports soared by 48.6%, reflecting the exceptional growth in squash and fish exports, and imports declined marginally. The trade deficit narrowed slightly to around 33% of GDP in FY2002, from 35% a year earlier. Remittances continued to be the major source of foreign exchange, and increased significantly in FY2002 to around 50% of GDP from around 40% in FY2001. Reflecting these developments, the current account recorded a surplus of 5.5% of GDP in FY2002, following 2 years of significant deficits. However, foreign reserves were under pressure due to capital outflows for most of the fiscal year but improved significantly in the last quarter, boosted by large official capital inflows related to the EPSRP loan. Reserves were boosted from 2.3 to 3.6 months of imports as of end-June 2002. However, the foreign reserves again came under pressure and represented less than 2 months of import cover by the end of the calendar year 2002. The official external debt (including that of public corporations) declined marginally to 45.7% of GDP. The debt service ratio dropped from 21.8% to 8.2% of exports of goods and services as of end-FY2002, largely reflecting a decline in scheduled principal repayments.

The pa'anga continued to depreciate in nominal effective terms by a further 9.2% at end-FY2002, after its 11.5% depreciation in end-FY2001. The surge in Tonga's inflation rate relative to that of its trading partners meant that the real effective exchange rate seems to have stabilized in 2002, despite the nominal effective depreciation.

Policy Developments

The government budget for FY2003 is expansionary. However, the projected deficit at 2.9% of GDP is to be financed entirely with external concessional funds. In addition, the budget proposes to start implementing a strategy to reduce wages to more sustainable levels, specifically to 50% of total current expenditures less interest payments in the medium term. In FY2003, 158 civil service posts are to be abolished and a further 425 vacant positions will remain unfilled.

The Government has embarked on a comprehensive EPSRP with the support of a loan and technical assistance from ADB. The reforms are intended to improve public sector governance and the investment environment for business. There is clear evidence of a commitment and progress with the EPSRP. New Public Service, Public Finance Management, Public Enterprise, Revenue Services Administration, Business Licensing, and Foreign Investment acts were passed in 2002. Proposals are being developed for a comprehensive tax reform. The distortionary Industrial Development Incentives Act was suspended in 2001 and is to be repealed as part of the tax reform. The resultant streamlining and improved transparency of the complex licensing system should help significantly in promoting private sector development.

The fiscal position remains difficult, inflation has escalated, and foreign reserves are still under pressure. Although inflationary, currency depreciation helped alleviate some of the macroeconomic pressure felt in the past 2 years. Export competitiveness improved, as reflected in the depreciation of the real effective exchange rate by 8.5% from mid-2000 to mid-2002 (although the real effective exchange rate seems to have stabilized in 2002). Further exchange rate depreciation may be needed as the economy adjusts. The use of credit ceiling guidelines has had limited effectiveness in slowing credit growth to the private sector. At present, there are no penalties for banks that breach the guidelines. Given the current macroeconomic circumstances, more effective monetary control arrangements are called for. This would require a significant improvement in the balance sheet of the central bank.

Tax reform is a priority for the Government. The economy relies heavily on trade taxes and the current tax system has numerous economic distortions. The existing tax regime will also come under some pressure when PICTA, which Tonga has signed, is implemented. A recent World Bank study estimated that the potential revenue loss from trade diversion could easily range up to 15% of total tariff revenues, which equates to about 7% of total revenues and grants based on data for FY2003. There are also substantial capacity constraints in the administration of all major taxes, providing potential for considerable tax evasion and avoidance. Tax reform is a major component of the EPSRP. There are well-developed proposals for reducing the reliance on trade taxes, broadening the existing sales tax base, and improving the economic efficiency, equity, and revenue effectiveness of the tax regime. However, major efforts will be needed to improve administrative capacity if the tax reform program is to be successful.

The EPSRP includes civil service and public enterprise reforms aimed at reducing costs while improving both service delivery and the private sector regulatory environment. In addition to the new Public Enterprises Act (associated with EPSRP implementation), there is a need for complementary regulatory changes for monopoly public enterprises, guidelines for board appointments, and considerable resources to implement performance monitoring—since the reform of public enterprises in most jurisdictions has proven to be challenging. The EPSRP also contains a commitment to pass a new immigration act to make it easier for foreign investors and key staff to obtain visas.

Outlook for 2003-2004

GDP is forecast to grow by 2.5% in FY2003 and by 2.7% in FY2004 as the reform program gathers momentum. Inflation is expected to remain relatively high at around 10% in FY2003 but to gradually moderate in FY2004. The inflation rate reflects the recent expansionary pressures and the continuing flow-on effects of a weaker currency. The pressure on the external account is expected to ease in the medium term as reforms and improvement in fiscal management progress, and as remittances and tourism continue to grow.

Growth over the next 2 years is expected to be reasonably broad based, but tourism could perform well as Tonga has the potential to benefit from the diversion of tourists from other locations in the Asia-Pacific region perceived to suffer from public security risks.

The outlook for fishing is a concern, as is the heavy reliance of the economy on remittances from Tongans abroad. If 2002's high level of remittances does not continue, the economy could easily slump, jeopardizing efforts to improve the fiscal and external positions and placing further pressure on the currency. The downside risks for growth, the currency, and inflation are much greater than the upside risks and the authorities will need to be vigilant in their efforts to manage the macroeconomic situation.

The EPSRP is ambitious in scope and content, and will require sustained political commitment and significant resources to help ensure success. If measurable progress can be made on the urgent task of fiscal consolidation and the medium- to longer-term tasks of reforming the civil service, public enterprises, and the tax system, the result should be a more resilient economy and general improvements in the standard of living. In the medium to longer term, it should be possible to achieve a per capita growth rate of 2.5% over a sustained period.

The 2003 budget projects a rise in total revenues and grants of 15.5%, based on a projection of significant rises in both tax and nontax revenues, and of grants. The budget item on total expenditures and net lending is projected to increase by 23.0%, with subsidies and other transfers as well as capital expenditures surging.

However, the outcome could well be a higher deficit than budgeted, especially if economic growth and associated government revenues are weaker than projected and public enterprises increase their demands on the budget.

Back Democratic Republic of Timor-Leste	Next Tuvalu