Tongan economy came back after volcano and Covid says IMF, but major reforms are needed

The Tongan economy is rebounding strongly according to the International Monetary Fund. However, the IMF said the economic outlook was uncertain and urgent improvements needed to be made.

The IMF said Tonga had suffered from a major double shock in early 2022. After an estimated contraction of two percent, real GDP was estimated to have expanded by 2.6 percent in the financial year from July 2022-June 2023.

The support measures deployed in response to the Hunga Tonga‒Hunga Ha’apai volcanic eruption and tsunami and the local COVID-19 outbreak in January-February 2022, together with aid from the international community, reduced the impact of the socioeconomic fallouts. Recovery after the eruption was driven by strong domestic demand and a pickup in tourist arrivals following once the border was re-opened in August 2022.

However, the kingdom still faced economic pressures. Inflation peaked at 14.1 percent in September 2022, but dropped to 6.6 percent in May 2023. The flow of  remittances was expected to drop from an estimated 44.2 percent of GDP in FY2023 to 39.7 percent in FY2024. Average inflation is projected to be 5.8 percent in FY2024.

The tsunami has also caused soil contamination.

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.

Tonga’s limited productive capacity and strong foreign demand for Tongan workers have significantly increased inflation risks. A sharp increase in global commodity prices could reduce households’ real purchasing power.

The IMF has warned that Tonga is at high risk of debt distress . Without additional grant commitments to IMF staff’s baseline projection, the present value of public debt-to-GDP ratio is projected to remain above the 70 percent debt-distress benchmark starting in FY2033. This reflects significant development spending needs to achieve its climate resilience and Sustainable Development Goals (SDGs). Debt obligations are largely external, with over half to China Exim Bank. Debt repayments are expected to surge in FY2024, and stay elevated at over three percent of GDP until FY2027.

The IMF has warned that delays in reconstruction and persistently high inflation will incur substantial welfare costs, especially for low-income households and small businesses. The IMF said the Tongan government’s monetary policy should focused on safeguarding price stability and providing ample financial support to the vulnerable, while postponing non-urgent spending.

The government has phased out most pandemic- and volcano-related tax exemptions and plan to gradually normalize current spending, including by limiting the public sector wage bill. The government should also prioritize on the execution of budgets related to reconstruction and social protection.

To achieve the necessary fiscal adjustments, the government needed to reform revenue administration, spending efficiency, and transparency.  Reducing tax exemptions,  setting clear eligibility criteria and allowing the Minister of Finance to have the ultimate authority to grant exemptions would help deliver significant additional revenues and ensure that exemptions are adequately aligned with national strategic objectives.

Enhancing resilience to natural disasters and climate change is a top reform priority . The Disaster Risk Management Act of 2023 marked an important step forward in this regard. It aims to pivot the focus of Tonga’s disaster management frameworks to risk mitigation and preparedness, including by improving coordination across relevant ministries and management of scarce. Expanding the classification of climate change-related spending and strengthening the social protection system were other priorities. Stricter enforcement of the Building Code, especially for residential properties, and facilitating relocation to safer grounds would significantly contribute to enhancing disaster resilience, which should be supported by allocation of adequate fiscal resources.

Developing the private sector was critical to boost Tonga’s growth potential. Other important reform priorities included increasing government spending on education and training, especially to reduce the skill mismatch in the domestic labour market; reducing gender inequality in the labour market, by enacting the Employment Relations Bill which would help better protect women in vulnerable work environments and cutting red tape hindering private sector investment, especially by improving the efficiency of land leasehold administration.

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