IMF Article IV Consultations

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STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION | Released on 26 May 2016

Key Issues

Outlook and risks. Since FY2013, Tonga has been on a growth path supported by the reconstruction in the aftermath of the 2014 Cyclone Ian, tourism, and remittances, and benefiting from low global fuel prices. In the medium term, growth is projected to be driven by economic activity in preparation to the Sixteenth South Pacific Games (the SPG) in 2019, while inflation is expected to remain low. International reserves are expected to remain at a comfortable level, supported by strong donor inflows, high remittances, and low costs of fuel imports. After weakening in FY2016 as a result of strong wage growth, the fiscal position is projected to improve gradually in the medium-term. Main risks to the outlook stem from a protracted period of slower growth in advanced and emerging economies, natural disasters, and fiscal pressure to raise government wages or as a result of cost overruns for the SPG and shortfalls in donor aid.

Challenges. The main challenge for Tonga in the medium term is to improve its growth potential and to create jobs for the young population, which would require expanding opportunities for private sector development. Given Tonga’s vulnerabilities stemming from its small size, remoteness, narrow export base, dependence on fuel imports, and exposure to natural disasters, ensuring macroeconomic and financial stability will remain a key challenge.

Key policy advice Tonga needs to improve resilience to shocks by building buffers and to undertake structural reforms to support private sector development and economic diversification. The key policy recommendations are: (i) contain wage growth and build sound fiscal position by gradually increasing the primary balance to ensure fiscal sustainability; (ii) maintain gross reserves at the current level to bolster resilience to shocks; (iii) lower the current inflation reference rate; (iv) strengthen monetary policy framework, including by introducing a policy interest rate and associated instruments, and develop macroprudential tools to better manage liquidity and credit cycle; and (v) enhance business-enabling structural reforms and improve efficiency of the public sector to raise growth potential.


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