Catalog

	Table of Contents
p. 63 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions 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 Republic of Palau Papua New Guinea Samoa Solomon Islands Democratic Republic of Timor-Leste Tonga Tuvalu Vanuatu III. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia

---

Tonga

Economic activity saw widespread weakening over the year to June 2004, and inflation rose. Nonetheless, progress was made in stabilizing the macroeconomy with the budget moving to surplus and international reserves rising to comfortable levels. The Government is continuing to pursue economic and public sector reform with the aim of achieving sustainable growth.

Macroeconomic assessment of 2004

Tonga experienced widespread weakening in economic activity in FY2004 (year ended 30 June 2004). Difficult trading conditions were reported by businesses across a range of industries, including wholesale and retail trade, manufacturing, transportation, power, and telecommunications. A shift to a budget surplus reduced the demand stimuli provided by the general government sector; the government-owned airline went into liquidation; the fish catch declined; the main agricultural export, squash, suffered a large fall in the international price; and there appears to have been an increase in the direct importing of household items at the expense of local traders. GDP growth is estimated to have slowed from 3.1% in FY2003 to 1.6% in FY2004.

The main areas of the economy to expand over FY2004 were tourism and construction. Tourist arrivals rose by 6% in the first 3 quarters of the year (relative to the corresponding period of the previous year), and over the same period tourism receipts are estimated to have risen by 15%, equivalent to 8% of GDP. The construction sector benefited from the continued reconstruction required by the 2001 cyclone, work on new church and cinema complexes, EU-funded projects, the Tonga High School project, and other residential buildings.

Inflation continued at the double-digit rate of 11.0% in 2004, compared with 11.6% in 2003. This was attributable mainly to a rise in the price of imported items of 15.1% (compared with a 5.3% increase in the price of locally produced goods). Other factors were the substantial depreciation of the pa’anga against the currencies of New Zealand and Australia (the main sources of imports), higher world oil prices, a rise in the electricity price, and an increase in the tariff rates on alcohol and tobacco.

Despite the low growth and high inflation, efforts to stabilize the economy bore fruit. The FY2004 budget had provided for an overall deficit of 1.6% of GDP following a deficit of 3.1% in FY2003. However, tax collection was better than expected, a hiring freeze on nonessential vacant positions contributed to a wage bill 16.5% below budget, a large cut was made in capital expenditures, and other nonessential outlays were controlled. The preliminary outcome is for an overall surplus of 1.2% of GDP in FY2004. A further important change over the year was a shift from large domestic financing to a net repayment of domestic debt made possible by the surplus and substantial drawdowns of external financing.

International reserves had started the year at 2.4 months worth of imports, below the National Reserve Bank of Tonga’s comfort level of 3-4 months worth of imports. However, the receipt of loan funds from ADB, an increase in official development assistance, overseas borrowings by commercial banks to fund their domestic lending, and the refinancing of a large telecommunications project resulted in an increase in international reserves in November 2004 equivalent to 5.6 months worth of imports.

The Reserve Bank maintained a tight monetary policy stance in view of its concerns over the state of the macroeconomy. It kept its minimum lending rate at 12% in FY2004 and left the reserve deposit rate unchanged. Commercial bank lending rates registered a slight increase over the course of the year.

Total credit to the private sector contracted by 4.3% after rising by 12.6% in FY2003. The contraction was related to the refinancing of one major project and a decline in lending to transport and storage, fishing, and hotels and restaurants. The overall asset quality of the banking system weakened, mainly because of the downgrading of some large exposures. Nevertheless, the financial system remained sound. The risk-weighted capital base of the banking system improved and stayed above the Reserve Bank’s minimum level.

The Government put Royal Tongan Airlines into liquidation in May 2004 given its inability to continue financial support. One month earlier, financial difficulties had required the airline to return the aircraft used on international routes. The first 14 months of the aircraft’s operation had absorbed a government capital injection of $9 million, the equivalent of 20% of FY2004 expenditures and net lending.

As of end-FY2004, external public debt was the equivalent of 39% of GDP and domestic public debt 8%. Government-guaranteed debt was an additional 7% of GDP, most of which is provided to public enterprises.

Macroeconomic policy developments

The FY2005 budget sets a vision of achieving sustainable growth with social equity. It recognizes that low inflation, adequate international reserves, and a sustainable overall budget position will be required to achieve this, which in turn requires a continuation of the economic and public sector reform that began in 2001.

Improved methods of financial management are being introduced under the provisions of a new Finance Management Act. Medium-term initiatives include expanded coverage of a new accounting system, the placement of heads of department on contract, and revised arrangements for the payment of wages. Reforms to the tax system and public enterprises are also being pursued to strengthen the fiscal position and raise the efficiency of the economy.

The main revenue initiative proposed is the introduction, in April 2005, of a 15% VAT, to be called the Consumption Tax. This will replace a 5% sales tax, a fuel sales tax, and a 20% port services tax, and will allow for a reduction in individual and corporate income tax rates. Administration costs are to be kept low by requiring only businesses with a minimum annual turnover of approximately $50,000 to register for the tax, and this is expected to cover 260 or so businesses. Complementary administrative changes are being made to strengthen the revenue performance.

Implementation of public enterprise reform has been delayed until the financial implications of the liquidation of Royal Tongan Airlines are addressed. Once this matter is resolved, government attention will shift toward the privatization of three of the smaller public enterprises and the delayed corporatization of the post office and printing departments. Work is to continue on integrating funding requests from the public enterprises into the budget and on implementing new public enterprise management legislation.

The Government plans to adopt new legislation to strengthen the supervision of financial institutions by the Reserve Bank. It is also considering legislative changes to assist the bank in implementing monetary policy. Key issues to be faced are the bank’s recapitalization, its current ability to finance deficits, its independence in managing interest rates, and the method for setting the reserve requirements of the commercial banks. The Reserve Bank is also working with the Ministry of Finance to issue treasury bills that would allow the management of liquidity through open-market operations.

Outlook for 2005-2007 and medium-term trends

The latest official forecast is for growth of 2.8% over FY2005. The construction industry is estimated to have expanded by 5.0% in FY2004 and is expected to remain firm, buttressed by donor-funded projects, notably the rebuilding of the main hospital, and by an increased allocation of the Government’s own funds to capital. Continued expansion in tourism is foreseen, despite the loss of services from Royal Tongan Airlines, leading to overall growth in the services sector. Remittances are expected to increase and to underpin private consumption as source economies grow.

Agriculture and fishing are also expected to strengthen in FY2005. Greater volumes of squash, root crops, and kava are projected in response to better market conditions. Vanilla has the capacity for continued growth, provided that recent high prices are sustained, given that export volumes in FY2004 were half of the level achieved in FY1999. The fishing industry remains hampered by high transportation costs and a lack of capital for investment. Nonetheless, a reversal of the El Niño weather conditions is expected to help raise the catch over the medium term.

The Government’s intention was to have inflation under control by the time the Consumption Tax is introduced. This is unlikely as inflation was still high at 10.6% as of November 2004. The introduction of the Consumption Tax is expected to lead to an overall increase in prices, but the impact is intended to be one-off and not have a lasting inflationary effect.

The Reserve Bank’s monetary policy objectives have been to maintain an adequate level of official foreign reserves and to promote price stability. Concerns over the sustainability of the foreign reserves position and the continuing high level of inflation are likely to see monetary policy remain tight over the forecast period.

Medium-term prospects for the economy will be influenced by any loss in international competitiveness arising from high inflation. After macroeconomic stability had been eroded in FY2001, the Reserve Bank allowed the pa’anga to depreciate to compensate for rising inflation and to protect official reserves. The real effective exchange rate as measured against its basket of currencies fell by approximately 9% in FY2001, and this depreciation was largely maintained until FY2004. However, the depreciation in the real effective exchange rate was unwound in FY2004 (Figure 2.34), suggesting a significant loss of competitiveness.

A key risk to be managed over the next few years is the potential for a relaxation of the fiscal position. The FY2005 budget provides for a 23% increase in expenditures and net lending. Most of the additional spending is to be allocated to an 18% increase in wages and a fivefold increase in capital expenditures. Revenues and grants are budgeted to rise by only 8%, leading to a projected budget deficit for the year of 2.2% of GDP. Some 30% of the deficit is to be financed domestically. These estimates exclude the cost of shutting down Royal Tongan Airlines, which was not known at the time of budget preparation.

However, the actual outcome for FY2004 was substantially better than budgeted for the year, and continuing expenditure control can be expected to lead to a better than budgeted outcome in FY2005 as well. Planned improvements to the management of public enterprises offer considerable potential to strengthen the fiscal position. In FY2003, dividends of only $25,000 were received on the Government’s equity of $35 million, and half of the government-guaranteed borrowing to public enterprises was nonperforming. Even a small improvement from these levels could have a relatively large impact on government revenues.

Back Democratic Republic of Timor-Leste	Next Tuvalu