Although Tonga's economy is rebounding strongly from a major double shock in early 2022, Tonga is confronting important challenges to long-term growth posed by sustained worker outflows and increasingly frequent natural disasters, says the International Monetary Fund.

“Developing the private sector is critical to boost Tonga’s growth potential”, the IMF stated today, 7 August.

It also says the government should postpone non-urgent spending.

The Tonga: Staff Concluding Statement of the 2023 Article IV Mission [2] stated that Tonga's post-Hunga-Tonga Hunga-Ha‘apai (HTHH) volcanic eruption-tsunami  recovery in FY2023 has been driven by strong domestic demand and a pickup in tourist arrivals following the border reopening in August 2022.

“The bold policy support measures deployed in response to the HTHH volcanic eruption-tsunami and the local COVID-19 outbreak in January-February 2022, together with aid from the international community, were instrumental in mitigating the socioeconomic fallouts.”

This recovery, however, has been accompanied by emerging supply-side bottlenecks and inflation pressures.

Significant labour shortages

“Tonga is experiencing significant labour shortages resulting from increased demand from seasonal worker programs in Australia and New Zealand. Combined with slow progress in rebuilding damaged tourism facilities (e.g., hotels and resorts) and buoyant domestic demand supported by remittances, underlying inflationary pressures remain elevated, with core inflation showing no signs of easing since September 2022.”

Headline inflation peaked at 14.1 percent in September 2022 and has since moderated to 6.6 percent in May 2023, driven by the decline in global energy prices and monetary policy tightening in trading partner economies.

Key findings

• Credit has started to expand. Bank credit growth has turned positive since September 2022 and reached 5.9 percent (y/y) in May 2023.
• The economic outlook is uncertain in the short term. Growth in FY2024 is projected at 2.5 percent, underpinned by public investment.
• The medium-to-long-term growth prospects are weak. Tonga’s long-term growth is projected at 1.2 percent, reflecting its exposure to increasingly frequent natural disasters, persistent loss of workers to emigration, and limited economies of scale due to geographical barriers.
• Risks are tilted to the downside. Tonga’s limited productive capacity and strong foreign demand for Tongan workers have significantly increased inflation risks.
• Tonga is assessed as being at high risk of debt distress . Without additional grant commitments to IMF staff’s baseline projection, the present value (PV) of public debt-to-GDP ratio is projected to rise and remain above the 70 percent debt-distress benchmark starting in FY2033....Debt repayments are expected to surge in FY2024, mainly to China Exim Bank, and stay elevated at over 3 percent of GDP until FY2027.

Remittances

Tonga continued to receive sizable remittances and donors' budget support in FY2023 and saw a rebound in tourist arrivals. However, imports have simultaneously increased, driven by higher demand for reconstruction-related capital goods.

Policies to Promote Sustainable and Inclusive Growth
The IMF states: “Macroeconomic policy settings should be aimed at simultaneously supporting reconstruction and tackling inflation in the near term. Both delays in reconstruction and persistently high inflation would incur substantial welfare costs, especially for low-income households and small businesses. Achieving this dual objective requires an all-government effort, with monetary policy focused on safeguarding price stability and fiscal policy on providing ample financial support to the vulnerable while postponing non-urgent spending.

Other key points:

Beyond the near term, a combination of domestic fiscal measures and additional donor support is required to meet Tonga’s development spending needs while minimizing the risk of debt distress.

• To achieve the necessary fiscal adjustments, reforms to improve revenue administration, spending efficiency, and transparency are essential;
• Further actions are needed to contain underlying inflation pressures;
• The banking sector remains well capitalized and liquid;
• Enhancing resilience to natural disasters and climate change is a top structural reform priority;
• Developing the private sector is critical to boost Tonga’s growth potential;

A national digital ID system is a significant measure. “To reap the full benefits, however, this initiative should be reinforced by a government-wide drive to make public administration less paper-based and greater investment in information and communication infrastructure to improve the coverage and quality of internet connection.”

Other important reform priorities include:

• increasing government spending on education and training, especially to reduce the skill mismatch in the domestic labour market in the context of continuing worker outflows;
• reducing gender inequality in the labour market, including by enacting the Employment Relations Bill, which would help better protect women in vulnerable work environments;
• cutting red tape hindering private sector investment, especially by improving the efficiency of land leasehold administration (e.g., adoption of necessary IT systems), and
• strengthening the Money Laundering framework.

The IMF stated that delays in publishing core macroeconomic data, like national accounts and external sector statistics, have become more prolonged and frequent in recent years.

“The requirements under the current law on data sharing and cooperation by relevant ministries need to be more strictly enforced,” it said.