Regions and Countries

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p. 2 of 5 BACK | NEXT I. Country Strategy II. Current Development Trends and Issues III. Implementation of the Country Strategy and Program IV.Portfolio Management Issues V. Country Performance and Lending Levels

Country Strategy and Program Update 2003-2005: Tonga

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II. Current Development Trends and Issues

A. Recent Political Developments

4. The appointment of the reform minded minister for finance by the Privy Council in 2001 to support a similarly minded Prime Minister has improved the impetus for the EPSRP. The Prime Minister and the minister of finance steered cabinet endorsement of the EPSRP in early 2002. The EPSRP is supported by the recently approved ADB program loan³ for US$10 million as well as complementary support from other funding agencies.

5. The result of the March 2002 election does not change the composition of Parliament nor improve its influence on policy decision-making processes. However, the Government is conscious of the increasing need to inform and involve the community in the implementation of its reform agenda, as evidenced by the establishment of the Social Impact Monitoring Unit as part of the EPSRP. Also, in April 2002, the Government formally launched its reform program, providing details of the key reform objectives and activities to the community through the media and civil society representatives.

6. The Government is taking legal action in the US courts against the former court jester to recover Tonga Trust Fund monies that were lost in various risky investments. Additionally, following adverse publicity against Tongan-registered ships being involved in illegal arms transport and people smuggling, the Government shut down the ship registry business in May 2002.

B. Economic Assessment and Outlook

7. Real gross domestic product (GDP) growth at 2.7% in FY1994/95 was followed by 2 years of recession/stagnation and then acceleration to 6.2% in FY1999/2000 mainly due to the impact of the millennium celebrations. Growth slowed to an estimated 3.0% in FY2000/01. Two factors were noteworthy for the period 1993–2000: consumption substantially exceeded domestic production, with the domestic saving ratio averaging minus 21.6%; and government administration and community services became increasingly important in the monetary economy (an annual growth rate of 5.0% and accounting for 18.2% of GDP in FY2000/01). The continued growth of government spending was not sustainable, as it relied on rising taxes and/or deficit financing, neither of which was limitless. The inflation rate accelerated to 6.3% in FY2000/01 (and stood at around 10.5% by the end of 2001) due to expansionary fiscal and monetary policies and substantial currency depreciation.

8. The fiscal situation deteriorated in 2001, largely reflecting a civil service wage rise, a shortfall in nontax revenue, and a substantial increase in total net lending to support some ailing public enterprises. The wages share of current expenditure reached 57%, and the current budget was in deficit of about 0.5% of GDP. The overall budget deficit was 2.6% of GDP, which was largely financed by advances from the domestic banking system and also by some bond issues. The public domestic debt outstanding rose to around T$40.0 million by the end of 2001. There was in addition an estimated T$32 million unfunded liability arising from the civil servants’ retirement scheme introduced in 1999. By mid-2001, the assets of the Tonga Trust Fund, which is held mainly offshore and maintained separately from the budget and official foreign reserves, had been almost depleted due to poor (and possibly fraudulent) management. The remaining funds (estimated at less than T$6 million) are frozen pending an investigation.

9. Broad money rose by an estimated 26.5% in FY2000/01. Domestic credit expanded by 31.3%, with private sector credit increasing by 24.8% (partly reflecting a large loan for importation of telecommunications equipment), and net credit to Government rising more than five-fold to finance the fiscal deficit. Credit to nonfinancial public enterprises more than doubled. The effectiveness of the monetary policy remained constrained by the weakness of the central bank’s balance sheet, and increased reliance was placed on credit ceilings. The weighted average deposit rate dropped marginally to 4.7% in 2001. The base lending rate was stable at 9.0%, so that the interest rate spread increased slightly. With the acceleration in the inflation rate, the real deposit rate became negative.

10. The trade deficit shrank to approximately one third of GDP in 2001 as merchandise exports, consisting primarily of squash and fish, increased 3.7%, and imports declined 4.3% due to weak domestic demand. Net private transfers from Tongans living abroad continued to be the major source of foreign exchange at about four times the value of exports. Remittances continued to increase post-September 2001 to around T$120 million, an increase of 20% over a year earlier. However, the services account turned negative due to payments made to Australia in connection with aircraft leasing arrangements, and net investment income flows were also negative. The current account recorded a deficit equivalent to 8.2% of GDP. The capital account surplus fell further from a historically low level in 2000 due to an increase in Tongans’ overseas investments and the purchase of a foreign-owned supermarket. The level of official foreign reserves by the end of 2001 was around T$30 million, or 2.8 months of imports. The official external debt (including that of public corporations) stood at 44.6% of GDP. The debt service ratio was 19.5% of exports of goods and services. The pa’anga depreciated 11.0% in nominal terms and 6.8% in real effective terms.

11. An update of the Tongan economic outlook was presented at the Consultative Group meeting in April 2002, in which the Government acknowledged worsening economic prospects, given that the economy recorded virtual zero growth for FY2001/02 and the annual inflation rate was around 10.7% at the end of January 2002. However the measures taken by the Government since mid-2001 to contain public sector expenditure appear to be successful, as the budget deficit for FY2001/02 was expected to be broadly the same as that for FY2000/01 at around 2.5% of GDP. The upward trend of overseas remittances continuing into the first two months of 2002 helped to keep foreign reserves at T$25 million at the end of February and at around 2.6 months of import cover compared with the National Reserve Bank’s target of 3 months. Tonga’s country economic indicators are in Appendix 2, Table A2.1.

C. Implications for Country Strategy and Program

12. SDP7 identifies three key themes to achieve its strategic objectives by 2025: restructuring for higher sustainable economic growth, ensuring financial stability, and investing in Tonga’s people. The recently published Pacific island economic report for Tonga⁴ confirms that the agriculture, fishery, and tourism sectors are the areas with the greatest potential to contribute to economic growth. This growth is expected to come from private sector investment, with the Government providing support infrastructure and an improved policy environment. As part of its reform strategy the Government has already initiated changes to the relevant legislation to provide incentives for the development of small and medium enterprises (SMEs): implementing a more predictable business licensing system, improving the clarity of visa requirements and predictability in the granting of visas to foreign investors, and legislating a new foreign investment act.

13. ADB approved the US$10 million loan to support two important elements of the comprehensive reform program: to achieve fiscal balance by FY2004/05, and to improve public service efficiency and effectiveness. Given the virtual zero growth since September 2001, it is important that urgent actions are undertaken to kickstart economic growth through assisting the development of private businesses. Rationalization of public enterprises also needs to accelerate to ensure that government demand on the rest of the economy is shrinking; and where appropriate, commercial activities should be transferred to the private sector through privatization.

14. The increased remittances from expatriate Tongans post-September 2001, the strength of certain agricultural exports, and a slightly better than expected budget deficit for FY2001/02 provide breathing space for the Government to speed up its comprehensive reform program. The Government intends to push ahead with its reform activities as far as practicable, taking into account external assistance and government resources (particularly staff capacity).

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