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Document of
The World Bank
FOR OFFICIAL USE ONLY
Report No. 64671-TO
INTERNATIONAL DEVELOPMENT ASSOCIATION
PROGRAM DOCUMENT
FOR A
PROPOSED GRANT
IN THE AMOUNT OF SDR 5.8 MILLION
(US$9 MILLION EQUIVALENT)
TO
THE KINGDOM OF TONGA
FOR AN
ECONOMIC RECOVERY OPERATION
OCTOBER 21, 2011
Poverty Reduction and Economic Management Unit
PNG and Pacific Islands Country Department
East Asia and Pacific Region
This document has a restricted distribution and may be used by recipients only in the performance of their official
duties. Its contents may not otherwise be disclosed without World Bank authorization.
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Kingdom of Tonga
GOVERNMENT FISCAL YEAR
July 1 – June 30
CURRENCY EQUIVALENTS
(Exchange Rate Effective of September 15, 2011)
Currency Unit Tonga Pa‟anga
USD 1.00 TOP 1.67
WEIGHTS AND MEASURES
Metric System
ABBREVIATION AND ACRONYMS
ADB Asian Development Bank NRBT National Reserve Bank of Tonga
AFS Annual Financial Statements NZ-IDG New Zealand Ministry for Foreign
Affairs and Trade International
Development Group
AMPs Annual Management Plans PAC Public Accounts Committee
AusAID Australian Agency for International
Development
PEFA Public Expenditure and Financial
Accountability
CAS Country Assistance Strategy PERs Public Expenditure Reviews
CPIA Country Policy and Institutional Assessment PFM Public Financial Management
DSA Debt Sustainability Analysis PFTAC Pacific Financial Technical
Assistance Center
EC Delegation of the Pacific of the European
Commission
PRIF Pacific Region Infrastructure
Facility
EXIM Export Import Bank of China PSC Public Service Commission
FY Fiscal Year PV Present Value
GDP Gross Domestic Product SDR Standard Drawing Rights
GNI Gross National Income TCA Tonga Competent Authority
GoT Government of Tonga TERM Tonga Energy Road Map
HDI Human Development Index TTL Task Team Leader
HIES Household Income and Expenditure Survey TPL Tonga Power Limited
IDA International Development Association TSA Treasury Single Account
IFC International Finance Corporation TSDF Tonga Strategic Development
Framework
IMF International Monetary Fund US United States
LPG Liquefied Petroleum Gas
MTBF Medium-Term Budget Framework
Vice President:
Country Director:
Sector Director:
Lead Economist:
Task Team Leader:
James W. Adams
Ferid Belhaj
Ivailo Izvorski (Acting)
Vivek Suri
Virginia Horscroft
KINGDOM OF TONGA
ECONOMIC RECOVERY OPERATION
TABLE OF CONTENTS
GRANT AND PROGRAM SUMMARY ...................................................................................................... 1 I. INTRODUCTION ............................................................................................................................ 1 II. COUNTRY CONTEXT ................................................................................................................... 4
RECENT ECONOMIC DEVELOPMENTS IN TONGA ................................................... 4 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ............................... 8
III. THE GOVERNMENT‟S PROGRAM AND PARTICIPATORY PROCESSES ....................... 11 IV. BANK SUPPORT TO THE GOVERNMENT‟S PROGRAM ..................................................... 13
LINK TO COUNTRY ASSISTANCE STRATEGY ........................................................... 13 COLLABORATION WITH THE IMF AND OTHER DONORS ....................................... 14 RELATIONSHIP TO OTHER BANK OPERATIONS ....................................................... 14 LESSONS LEARNED ......................................................................................................... 15 ANALYTICAL UNDERPINNINGS ................................................................................... 16
V. THE PROPOSED ECONOMIC RECOVERY OPERATION .................................................... 19 OPERATION DESCRIPTION ............................................................................................ 19 POLICY AREAS ................................................................................................................. 21
VI. OPERATION IMPLEMENTATION ............................................................................................. 33 POVERTY AND SOCIAL IMPACTS ................................................................................ 33 ENVIRONMENTAL ASPECTS ......................................................................................... 35 IMPLEMENTATION, MONITORING AND EVALUATION .......................................... 35 FIDUCIARY ASPECTS ...................................................................................................... 36 DISBURSEMENT AND AUDITING ................................................................................. 37 RISKS AND RISK MITIGATION ...................................................................................... 38
ANNEXES
ANNEX 1: LETTER OF DEVELOPMENT POLICY ................................................................................ 41 ANNEX 2: TONGA: ECONOMIC RECOVERY OPERATION POLICY MATRIX ........................... 44 ANNEX 3: FUND RELATIONS NOTE ....................................................................................................... 46 ANNEX 4: SUPPORTING DOCUMENTATION FOR PRIOR ACTIONS ............................................. 50 ANNEX 5: GOVERNMENT OF TONGA: MEDIUM-TERM REFORM MATRIX .............................. 51 ANNEX 6: COUNTRY AT A GLANCE ...................................................................................................... 56
MAP
TABLES IN TEXT
TABLE 1: RECENT FISCAL TRENDS, FY2006/07–FY2010/11..................................................................... 7
TABLE 2: SUMMARY OF MEDIUM-TERM MACROECONOMIC OUTLOOK.........................................11
TABLE 3: POVERTY INCIDENCE IN TONGA BY REGION, 2001 AND 2009.......................................... 19
TABLE 4: PRIOR ACTIONS AND TRIGGERS...............................................................................................21
CHARTS IN TEXT
CHART 1: REAL GDP GROWTH, FY2000/01–FY2010/11...............................................................................5
CHART 2: REMITTANCES, TOURISM RECEIPTS AND EXPORT RECEIPTS, FY2005/06–FY2009/10....6
The Economic Recovery Operation was prepared by an IDA team consisting of: Virginia Horscroft (TTL), Economist,
EASPR; Vivek Suri, Lead Economist, EASPR; Saia Faletau, Focal Officer, Tonga Liaison Office; Wendy Hughes, Senior
Energy Specialist, EASNS; Tendai Gregan, Energy Specialist, EASNS; Manohar Sharma, Senior Poverty Specialist,
EASPR; Ximena Del Carpio, Economist, EASNS; Kalanidhi Subbarau, Consultant, AFTSP; Rob Jauncey, Senior Country
Officer, EACNF; Tobias Haque, Economist, EASPR; Thang-Long Ton, Economist, EASPR; Isabella Drossos, Senior
Counsel, LEGES; Stephen Hartung, Financial Management Specialist, EAPFM; Thao Le Nguyen, Senior Finance Officer,
CTRLN; Nathan Hale, Team Assistant, EACNF; Rideca Duarte, Team Assistant, EACDF; Samantha Evans, Team
Assistant, EACNF; Mildred Gonsalvez, Program Assistant, EASPR.
Peer Reviewers: Rob Taliercio, Lead Economist, EASPR; Francis Rowe, Senior Country Economist, SASEP.
GRANT AND PROGRAM SUMMARY
KINGDOM OF TONGA
ECONOMIC RECOVERY OPERATION
Borrower Kingdom of Tonga
Implementing Agency Ministry of Finance and National Planning
Financing Data IDA Grant
Standard IDA Grant terms
SDR 5.8 million (US$9 million equivalent)
Operation Type The proposed operation is the first in a multi-year programmatic
series of operations, the first of a single tranche US$9 million
equivalent and the second of a single tranche US$5 million
equivalent to be disbursed upon effectiveness.
Main Policy Areas The policy areas the proposed operation will support are:
(i) strengthening public financial management; (ii) strengthening
fiscal policy; (iii) promoting structural reform; and (iv) improving
social protection.
Key Outcome
Indicators
The key outcome indicators for the program over the medium
term are: (i) budget credibility at the level of disaggregated
expenditure; (ii) public access to key fiscal information; (iii) an
effectively managed civil service wage bill; (iv) electricity tariffs
that achieve full cost recovery; (v) the economic despatch of
electricity in the grid; (vi) cost savings in the petroleum supply
chain that are shared with consumers; (vii) a public enterprises
portfolio more focused on infrastructure services; (viii)
incremental employment and income generation in beneficiary
communities of the community public works program.
Program Development
Objective and
Contribution to CAS
The proposed operation will assist the Government of Tonga
(GoT) to implement key aspects of its medium-term reform
agenda, while providing a predictable flow of resources in a
challenging fiscal environment. Over the last four years, Tonga‟s
economy has been hit hard by a series of crises, which have
caused the economy to contract, a significant fiscal gap to
emerge, and poverty to increase sharply. At the same time, Tonga
has made the transition to a more democratic political system.
The proposed operation provides the Bank with an opportunity to
support key public sector and economic reforms at a critical
juncture in Tonga‟s development process.
The proposed operation contributes mainly to the first theme of
the CAS, of supporting policy reform to strengthen economic
growth prospects and improve service delivery. The policy
actions supported by the proposed operation will strengthen
critical aspects of public financial management as well as key
components of fiscal policy that underpin the delivery of services,
including revenue effort and management of the public service
wage bill. The policy actions also support essential structural
reforms, including in the critical energy sector as well as in public
enterprises. In addition, the policy actions support improved
social protection, contributing to the third theme of the CAS on
building resilience against shocks.
Risks and Risk
Mitigation
The main risks of the proposed operation and their associated
mitigation strategies are:
The thin capacity of the public sector in Tonga poses a risk
that the policy actions cannot be implemented as quickly or
successfully as expected. This risk has been mitigated through
the careful selection of a limited number of actions that are
key priorities to the GoT and that strike a balance between
actions that are more demanding on administrative resources
and actions that are more demanding on political resources.
Tonga‟s new political system, which has been reformed only
recently, poses a risk that the new government will be put
under pressure to deliver immediate benefits to constituents.
This risk has been mitigated through dialogue with the GoT
on macroeconomic issues, helping to strengthen awareness of
key macroeconomic challenges and resolve to maintain an
appropriate macroeconomic framework.
Uncertainty surrounding Tonga‟s external environment poses
the risk that a sharper than expected rise in global commodity
prices or further shock to remittance flows could undermine
the incipient economic recovery in Tonga and threaten fiscal
stability. This risk is being mitigated over the medium term
by efforts to rebuild Tonga‟s fiscal space to respond to
shocks. In the event of a serious near-term shock, however,
the GoT will require additional support from development
partners.
The dependence of Tonga‟s macroeconomic framework on
the continued availability of grants from development
partners poses the risk that delays in the receipt of grants may
lead to cash flow problems that undermine budget execution,
impede the normal functioning of government, and divert
attention from the reform agenda. This risk has been
mitigated by the Bank‟s efforts, at the GoT‟s request, to
coordinate the support of development partners for a joint,
multi-year reform matrix.
Tonga‟s high vulnerability to external economic shocks and
natural disasters may place stress on the macroeconomic
framework and undermine the implementation of the GoT‟s
reform agenda, if institutional resources need to be diverted to
respond to these shocks. The proposed operation helps to
mitigate this risk over the medium term, by contributing
resources to support the budget in a challenging fiscal period.
Operation ID P126453
1
IDA PROGRAM DOCUMENT
FOR A PROPOSED ECONOMIC RECOVERY OPERATION GRANT
TO THE KINGDOM OF TONGA
I. INTRODUCTION
1. The proposed operation will assist the Government of Tonga (GoT) to implement
key aspects of its medium-term reform agenda, while providing a predictable flow of
resources in a challenging fiscal environment. Over the last four years, Tonga‟s economy
has been hit hard by a series of crises, which have caused the economy to contract, a
significant fiscal gap to emerge, and poverty to increase sharply. The proposed operation will
support four major components of Tonga‟s development agenda: strengthening public
financial management; strengthening fiscal policy; promoting structural reform; and
improving social protection. The proposed multi-year programmatic series of operations
corresponds with the term in office of the first government in Tonga to be chosen by a
majority-elected parliament. It therefore provides the Bank with an opportunity to support key
public sector and economic reforms at a critical juncture in Tonga‟s development process.
2. Tonga‟s economy is beginning to recover from the series of crises that have
buffeted it in recent years, but the incipient recovery is dependent on external support. Tonga‟s economy has been adversely affected by the global food and fuel price crisis, a large
contraction in credit following a domestic credit bubble, the global economic crisis, and a
succession of natural disasters. The economic impact of these shocks has been mitigated by a
floor under government expenditure provided by budget support from development partners,
as well as by significant capital expenditure financed by concessional loans. Continued
external support, particularly budget support to maintain government expenditure, will be
required to allow the incipient recovery to become more firmly established over the medium
term. At the same time, it will be important for development partners to help sustain the
momentum of key public sector and economic reforms in this challenging period.
3. Tonga is a small, remote economy that is highly vulnerable to external shocks
and dependent on a limited number of sources of foreign exchange. Tonga has a very
small population of 104,000 and is extremely remote from its major markets. Small size and
remoteness combine to push up the cost of economic activity, limiting the scope for Tonga‟s
exports of goods and services to be competitive in world markets, and to raise the cost of
public services. Like other small, remote economies, Tonga depends on a limited number of
sources for its foreign exchange earnings – the main one being remittances from the large
number of Tongans who live and work abroad, which have averaged just under 32 percent of
GDP over the last decade. The openness of Tonga‟s economy and the lack of diversification
of its sources of foreign exchange make Tonga highly vulnerable to external economic
shocks. Its geographical characteristics also make it highly vulnerable to natural disasters.
4. In recent years, Tonga has undertaken a number of important public sector and
economic reforms, but robust economic growth has remained elusive. Tonga‟s reform
efforts have included the comprehensive reform of its tax policy and administration, concrete
steps to improve its business environment, and significant work to move its public enterprises
onto a more commercial footing. Reflecting these successes, Tonga‟s CPIA rating has
2
increased from 2.9 to 3.5 over the last five years, putting Tonga‟s policy and institutional
performance above average for IDA countries. Tonga‟s HDI rating is reasonably strong, with
Tonga ranked just within the „high human development‟ group of countries, and Tonga‟s GNI
per capita is also reasonably high among the Pacific Islands, at USD 3,260. Despite these
achievements, economic growth has been lacklustre, averaging about 1.5 percent per annum
during the last decade, at the same time as Tonga‟s population has grown at an average of
about 0.5 percent per annum. As in most small, vulnerable economies, Tonga‟s growth has
also been quite volatile, oscillating between about –1 percent and 3.5 percent over the course
of the decade. Economic growth was stronger in the early years of the decade but became
patchy thereafter, with the prospects of a sustained recovery remaining elusive in the face of
the multiple crises affecting the country in the latter part of the decade.
5. Over the last four years, the series of crises that have buffeted the Tongan
economy have caused economic contraction, a significant fiscal gap, and rising poverty. Given Tonga‟s high dependence on imported food and fuel, the global food and fuel crisis
caused significant detriment, with inflation peaking at 12 percent in mid-2008. A rapid build
up in non-performing loans following a lending surge in late 2007 and 2008 then precipitated
an extended contraction in domestic credit, which has continued to limit Tonga‟s growth
momentum. At the same time, the economy was damaged severely by the global economic
crisis, which had its main impact through a sharp decline in remittance receipts. The flow-on
impact of the decline in remittances was a sharp contraction in tax revenue, undermining the
GoT‟s capacity to fund its expenditure without budget support. A succession of natural
disasters has since hampered Tonga‟s recovery from the impact of the global economic crisis.
6. The GoT is acutely conscious of the increasing hardship facing households and
communities in Tonga, particularly in rural areas and the outer islands. By 2009, some
22.5 percent of the population were living below the basic needs poverty line, up from 16.2 in
2001. Outside the main island, basic needs poverty rose much more sharply, from 11.8
percent of the population in 2001 to 22.9 percent in 2009. In these other islands, access to
own-produced food is higher than in the capital, but there are fewer cash earning
opportunities. With census data suggesting that approximately three-quarters of Tongan
households receive remittances, the sharper increase in poverty in the outer islands is
consistent with recent increases in poverty being primarily the result of declines in
remittances, removing what for some households is a rare source of cash income. The GoT
places a high priority on introducing a social protection scheme to mitigate the increased
hardship facing vulnerable households and communities, an initiative that the proposed
operation is designed to support.
7. The proposed multi-year programmatic series of operations will assist the GoT to
appropriately sequence key public sector and economic reforms over a medium-term
time horizon, while supporting the GoT‟s capacity to deliver services in a challenging
fiscal environment. Within the area of public financial management, the GoT‟s reform
agenda covers strengthening the building blocks of the public financial management system,
strengthening budget execution, increasing the transparency of key budget processes and
increasing the credibility of the budget. Under fiscal policy, the agenda covers strengthening
revenue effort, improving the quality of expenditure, and improving the management of the
civil service wage bill. Within the sphere of structural reform, the agenda encompasses energy
sector reform, public enterprise reform and private sector development. The reform agenda
also includes the development of a community-based social protection scheme. The budget
3
support provided by the Bank under the proposed multi-year programmatic series of
operations will enable the GoT to maintain essential public services and undertake essential
capital projects over the medium-term, in a challenging fiscal environment.
8. The proposed program is the product of a very strong policy dialogue between
the Bank and the GoT. In late 2010, the Bank worked closely with the Ministry of Finance
on macro-fiscal analysis, which strengthened the ability of the Ministry of Finance to inform
the new government about Tonga‟s challenging economic and fiscal environment. Since then,
the Bank has continued to work closely with the GoT to assist its deliberations on a range of
macroeconomic issues, and to support the development of its broader public sector and
economic reform agenda. A key aspect of the Bank‟s dialogue with the GoT concerns the
critical energy sector, which builds on the Bank‟s two-year engagement as the lead
development partner in this field. That extensive engagement underpinned the Bank‟s Energy
Sector Development Policy Operation in late 2010, which the current operation helps to take
forward through further key policy actions.
9. The Bank has played the coordinating role among development partners in the
policy dialogue with the GoT over a medium term reform program, to which a number
of development partners are attaching budget support. The GoT requested development
partners to work together with the GoT to develop a common policy matrix for budget support
over the medium term, and requested the Bank to coordinate this endeavour. The World Bank
has worked closely with the Asian Development Bank (ADB), the Australian Agency for
International Development (AusAID), the Delegation for the Pacific of the European
Commission (EC), the New Zealand Ministry for Foreign Affairs and Trade‟s International
Development Group (NZ-IDG) and the Pacific Financial Technical Assistance Centre
(PFTAC) in developing this common policy matrix. Development partners will jointly
support this reform agenda over the medium term. AusAID and NZ-IDG have attached
budget support to this common matrix, and the EC is planning to attach its future budget
support to a sub-set of policy actions from the matrix. The GoT is looking forward to a
predictable flow of budget support from key development partners, and to consolidated efforts
by development partners to support the implementation of the GoT‟s reform agenda over the
medium term.
10. The proposed operation carries a high risk on account of the limited institutional
capacity of the GoT, the recent nature of Tonga‟s political reforms, and Tonga‟s
uncertain external environment. First, the thin capacity of its public sector leaves the GoT
vulnerable to weaknesses in implementing its reform agenda. Secondly, Tonga‟s political
system has been reformed only recently, thus it is not yet clear how it would respond in the
event of a major shock. Thirdly, uncertainty exists with respect to the macroeconomic
environment due to Tonga‟s uncertain external environment. Tonga is highly dependent on
remittances, which may suffer a further shock, depending on the global fallout of the
unfolding European debt crisis and the path taken by the weak US economy in the near future.
Fourthly, Tonga‟s macroeconomic framework also depends on the continued availability of
grants from development partners over the medium term, adding a further degree of
uncertainty. Fifthly, Tonga is extremely vulnerable to external economic shocks and natural
disasters, events that may place undue stress on the macroeconomic framework and the
implementation of the GoT‟s reform agenda.
4
II. COUNTRY CONTEXT
RECENT ECONOMIC DEVELOPMENTS IN TONGA
11. Tonga is a small, remote economy that is highly vulnerable to external economic
shocks and natural disasters. Tonga‟s population of 104,000 is dispersed across 36 of the
176 islands that make up the archipelago. Located in the South Pacific, Tonga is one of the
most remote countries in the world, when measured by indicators of proximity to major
markets.1 Small size and remoteness combine to push up the cost of economic activity in
Tonga, limiting the scope for its exports of goods and services to be competitive in world
markets. These same factors also push up the cost of providing public services, due to
Tonga‟s limited potential to exploit economies of scale in public sector activities. In addition,
the openness of Tonga‟s economy and the lack of diversification of its sources of foreign
exchange make Tonga highly vulnerable to external economic shocks, while its geographical
characteristics make it highly vulnerable to natural disasters.
12. Like other small, remote economies, Tonga depends on a very limited number of
sources for its foreign exchange earnings. About one-third of Tongans live abroad –
primarily in the US, New Zealand and Australia – and the remittances they send home are
Tonga‟s largest source of foreign exchange, averaging just under 32 percent of GDP over the
last decade. Tourism receipts are Tonga‟s next largest source of foreign exchange, averaging
about 6 percent of GDP over the last decade. Over this period, tourism receipts have been on
an increasing trend. In contrast, Tonga‟s merchandise export receipts – which have averaged
about 5 percent of GDP over the last decade – have been on a declining trend. This has been
due largely to the decline of Tonga‟s major agricultural export, which suffered from disease
problems and was progressively out-competed in its key niche market. Tonga also receives
significant development assistance, with cash grants averaging 3 percent of GDP over the last
decade but 5.1 percent of GDP over the last five years. (Tonga also receives significant in-
kind grants, which amounted to some 3–6 percent of GDP in each of the last two years.)
13. Also like other small, remote economies, Tonga has a relatively undiversified
economic base. Agriculture, forestry and fishing contribute approximately 20 percent of
Tonga‟s GDP, a share that has gradually declined over the last decade. Semi-subsistence
agriculture is, however, critical to the livelihoods of the majority of households in Tonga.
Secondary industries, particularly manufacturing and construction activities, also contribute
approximately 20 percent of Tonga‟s GDP. Service industries dominate the economy, among
which government services – at about 15.5 percent of GDP – are the largest component,
closely followed by commerce, restaurants and hotels – at about 14.5 percent of GDP. This
category is dominated by wholesale and retail trading activities, which largely distribute
imported goods (imports are equivalent to about 40 percent of GDP).
14. Tonga has successfully undertaken a number of important public sector and
economic reforms in recent years. In conjunction with its accession to the World Trade
Organisation in 2007, Tonga thoroughly reformed its tax policy, and has subsequently
implemented comprehensive reforms to its customs and revenue administration. It has taken
steps to improve its business environment, particularly in the area of companies registration,
which have been reflected in improved ratings on the relevant IFC Doing Business indicators
1 See Gibson (2006) Are the Pacific Island Economies Growth Failures? Macmillan Brown Centre for Pacific
Studies: Working Paper No. 3, Pasifika Interactions Project.
5
over the last five years. Tonga has also taken steps to move its public enterprises onto a more
commercial footing, through legislative reform, corporatisation and privatisation. Reflecting
these reforms, Tonga‟s CPIA rating has increased from 2.9 to 3.5 over the last five years.
15. Despite its reform efforts, robust economic growth has remained elusive. Over the
last decade, GDP growth has averaged about 1.5 percent per annum, while the population has
grown at an average of about 0.5 percent per annum. This level of growth is not exceptional,
given Tonga‟s small size and remoteness. As Chart 1 shows, economic growth was above 3
percent per annum in the early years of the last decade but then stagnated, due to the poor
performance of Tonga‟s key agricultural export, a prolonged civil service strike in response to
sweeping civil service reform proposals, and major civil disturbances sparked by protests
demanding political reform, which caused widespread damage to the capital, Nuku‟alofa. The
economy then began to recover, with growth of 2.7 percent in FY2007/08, but Tonga was not
able to build on this upswing, largely because it was buffeted by a series of crises.
Source: World Bank and International Monetary Fund.
16. Tonga was hit very hard by the global food and fuel price crisis. Food accounts for
44 percent of the consumer price index (two-thirds of it imported), transport accounts for 14
percent and domestic fuel and power for 12 percent. All grid-supplied electricity – which
accounts for over 98 percent of the electricity used in Tonga – is generated using imported
fuel. Households and businesses in Tonga are thus highly vulnerable to global food and fuel
price rises, with inflation reaching12 percent in mid-2008. The crisis is estimated to have had
its severest impact on the urban poor, who have little land and must pay cash for food. Rural
populations and those on the outer islands, relying more on subsistence farming, are more
likely to have been able to switch towards traditional root crops for their staple diet.
17. An extended contraction in domestic credit has limited Tonga‟s economic
growth. Tonga‟s major commercial banks employed inadequate risk management during a
lending surge in late 2007 and 2008, resulting in a rapid build up of non-performing loans –
peaking at 20 percent in mid-2009. Even after a sharp contraction in credit in the latter half of
2008, the major banks have remained highly risk averse, maintaining tight lending standards
and remaining unwilling to lend. While the rate of contraction in credit has slowed, it is still in
-2%
-1%
0%
1%
2%
3%
4%
2000
/01
2001
/02
2002
/03
2003
/04
2004
/05
2005
/06
2006
/07
2007
/08
2008
/09
2009
/10
2010
/11
Chart 1: Real GDP Growth, FY2000/01–FY2010/11
6
negative territory. In the year to March 2011 private sector credit recorded a contraction of 9.4
percent, representing a continuing significant drag on the economy.
18. The global economic crisis has had a severe impact on Tonga. The main impact
has occurred through remittance receipts, as a result of the economic slowdown in key
remittance sending countries – the US (where over 50 percent of Tonga‟s remittances
originate), New Zealand and Australia. From being the equivalent of 31.1 percent of GDP in
FY2007/08, remittance receipts fell by 13.6 percent and 10.1 percent over the next two years,
to reach 22.5 percent of GDP in FY2009/10. At the same time, Tonga‟s tourist receipts also
declined, falling 13.3 percent in FY2009/10. Led by agricultural and fish exports,
merchandise exports continued their declining trend in FY2008/09 and FY2009/10. (See
Chart 2.)
Source: National Reserve Bank of Tonga.
19. As a result of the global economic crisis, Tonga‟s tax revenue has contracted
sharply. In FY2008/09 and FY2009/10, tax revenue fell 5.5 and 11.6 percent, respectively, in
nominal terms (see Table 1). The substantial decline in Tonga‟s remittances resulted in a
decline in imports, and consequently a reduction in tax revenue from consumption tax, import
duties and excises.2 Income and profits tax receipts also fell in FY2009/10, led by a drop in
large corporate tax receipts – as the major banks recorded losses as a result of provisioning for
bad debts, and the profits of the oil companies declined with oil prices. The contraction in tax
revenues induced by these crises was compounded by the coincidental timing of the
implementation of Tonga‟s comprehensive tax reforms during this period.3
2 While the earlier reforms to Tonga‟s tax policy were designed in part to shift the burden of taxation away from
trade taxes by reducing import tariffs, raising excises and introducing a consumption tax, the high proportion of consumption goods that are imported means that a significant proportion of tax revenue is still derived directly or indirectly from imports. In the context of the global food and fuel price crisis, the GoT also lowered the import tariff on meat and poultry and introduced an exemption for excise on fuel for inter-island transport. 3 Tonga‟s tax reforms were designed to be revenue-neutral, overall. For implementation purposes, they were
divided into two sets. The first set was implemented partway through FY2004/05 and had an overall positive impact on revenue receipts. The second set was intended to be implemented in FY2005/06 but was delayed until partway through FY2007/08. It had an offsetting overall negative impact on revenue receipts, with its full effect felt in the first full year after its implementation, which coincidentally was FY2008/09.
0
20
40
60
80
100
120
2005/06 2006/07 2007/08 2008/09 2009/10
Chart 2: Remittances, Tourism Receipts and Export Receipts,FY2005/06–FY2009/10 (Millions of USD)
Remittance Receipts Tourism Receipts Export Receipts
7
20. Government expenditure rose during the global economic crisis, partially
offsetting the detrimental impact of the crisis on the economy. In FY2008/09, total
expenditure and net lending rose by 17.2 percent, to fund a seven-fold increase in capital
expenditure, private sector development initiatives and the coronation. An extraordinary grant
from China enabled the GoT to fund these expenditures in the face of the unanticipated drop
in tax revenue, with a budget surplus of 0.1 percent of GDP.4 As a result of this stimulus,
GDP contracted only 0.1 percent in FY2008/09. In FY2009/10, total expenditure and net
lending rose by a further 21.6 percent. Capital expenditure and on-lending associated with two
loans from China‟s EXIM Bank more than offset the scaling back of the GoT‟s own higher
capital expenditure the previous year (these loans were a reconstruction loan contracted in late
2007 and a roads loan contracted in early 2010. Expenditure associated with higher project
grants from development partners accounted for another part of the rise in total expenditure
and net lending, as – to a smaller extent – did the implementation of a previously-agreed civil
service wage rise. Excluding expenditure associated with the EXIM loans and project grants
from development partners, government-funded expenditure in FY2009/10 remained at about
the same nominal level as in FY2008/09. This floor under the government-funded budget
depended on a budget support grant of 9.5 million pa‟anga (5.4 percent of the government-
funded budget) from the ADB. The overall deficit of 5.6 percent of GDP was financed
primarily by the drawdown of the EXIM loans. The stimulus provided by the budget support
and loan-financed expenditure contained the contraction in GDP to 0.5 percent.
21. The impact of the global economic crisis on Tonga‟s economic and fiscal situation
has been protracted. In FY2010/11, remittances are estimated to have declined a further 5.5
4 These figures exclude the public acquisition of the then private electricity supplier in FY2008/09, which the
Fund records below the line but the GoT has included above the line in its latest budget statement. (The figures for FY2008/09 in Table 1 are drawn from the latest budget statement, so include this acquisition above the line. For this reason, there will be discrepancies between the figures in Table 1 and those in Table 2.)
Table 1: Recent Fiscal Trends, FY2006/07–FY2010/11 (Millions of Pa'anga)
FY07 FY08 FY09 FY10 FY11(e)
Total revenue and grants 170.5 172.2 225.7 192.1 181.9
Tax revenue 126.0 139.1 131.5 116.2 115.0
Income and profits tax 26.4 26.8 40.3 28.1 23.5
Consumption tax 49.2 59.7 47.2 42.9 48.4
Trade taxes 47.6 40.5 16.1 14.9 13.2
Other taxes (incl. excises) 2.7 12.0 28.0 30.3 30.0
Non-tax revenue 22.3 24.5 21.2 27.3 17.5
Capital revenue 0.0 0.0 27.2 0.0 1.6
Project grants 22.3 8.7 45.8 39.2 24.9
Budget support grants 0.0 0.0 0.0 9.4 22.8
Total expenditure and net lending 164.7 161.4 220.6 230.1 238.0
Current expenditure 158.5 158.8 167.0 183.8 168.9
Wages and salaries 80.1 70.2 76.4 82.7 85.7
Contribution to retirement fund 5.8 4.4 5.2 6.9 7.2
Purchases of goods and services 49.9 65.5 61.9 69.4 51.5
Interest payment 3.2 4.2 5.2 5.6 6.4
Subsidies and transfers 19.5 14.5 18.3 19.2 18.2
Capital expenditure 5.6 2.6 19.1 18.4 52.0
of which EXIM-related 0.0 0.0 1.2 11.3 42.4
Net lending 0.6 0.0 34.6 27.9 17.1
of which EXIM-related 0.0 0.0 2.6 18.0 15.6
Overall balance 5.8 10.8 5.1 (38.0) (56.1)
Memorandum item:
Nominal GDP 611.0 661.4 663.2 681.4 752.9
Source: World Bank, International Monetary Fund, and Ministry of Finance
8
percent on the previous year, to reach their lowest nominal level since FY2001/02. Tourism
receipts are recovering but merchandise exports have continued to decline, with the lacklustre
performance of the agricultural sector. Tax revenue is estimated to have recorded a further
slight decline of 1 percent in FY2010/11, taking the total decline since FY2007/08 to some
17.5 percent in nominal terms. Total expenditure and net lending is estimated to have risen by
3.4 percent in FY2010/11, reflecting a near-doubling of the capital expenditure and on-
lending activity associated with the EXIM loans, mostly offset by a 10.4 percent contraction
in non-EXIM expenditure. A floor under government-funded expenditure was again provided
by budget support, with 22.8 million pa‟anga (13.2 percent of the government-funded budget)
provided from the World Bank (9.4 million pa‟anga), ADB (9.4 million pa‟anga) and AusAID
(4 million pa‟anga). In the absence of these budget support grants, the deficit would have been
10.5 percent of GDP. The deficit (after grants) of 7.5 percent of GDP was financed by the
drawdown of the EXIM loans. Estimated GDP growth of 1.2 percent in FY2010/11 is largely
due to the increased construction activity financed by the EXIM loans.
22. Tonga‟s recovery from the impact of the global economic crisis has been
hampered by a succession of natural disasters. In September 2009, Tonga was buffeted by
a tsunami, causing loss of life and significant material damage, particularly in the outlying
Niuas island group. In February 2010, a cyclone affected the whole of the archipelago, with
the worst impact in the Vava‟u island group, causing widespread material damage. In
February 2011, a cyclone hit the Ha‟apai island group, causing significant damage to
infrastructure and housing. Aside from the private costs of the natural disasters, these events
cause a periodic diversion of public resources away from implementing the development
program of the GoT and towards immediate reconstruction needs.
MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY
23. Tonga faces a number of macroeconomic challenges over the medium term, most
notably low-to-moderate economic growth, a large fiscal deficit, a high level of external
debt, and continued vulnerability to exogenous shocks. Inflation is expected to remain
elevated in FY2011/12, at an average of about 5.8 percent, as a result of continued high global
commodity prices, particularly for food and fuel. The current account deficit is also expected
to remain at an elevated level in FY2011/12, at about 11.7 percent of GDP, as EXIM-related
construction activity keeps imports high, and any recovery in remittances is fairly modest
(excluding EXIM, the projected current account deficit would be 6.8 percent). The deficit is
expected to be financed mainly by official capital flows (including EXIM loans). Reflecting
high levels of official transfers and capital flows (excluding EXIM loans), as well as weak
domestic consumption and tight credit conditions, foreign reserves are now at elevated levels
(equivalent to 6.4 months of imports at the end of March 2011). Reserves are expected to fall
in FY2011/12, as commodity prices rise and economic activity strengthens, but should remain
above four months of import cover due to the cushion provided by development assistance.
The National Reserve Bank of Tonga (NRBT) is maintaining an expansionary monetary
policy stance, which the Fund has assessed to be appropriate in the current economic context.
24. Tonga‟s economy is expected to grow by 1.7 percent in FY2011/12 and by about
1.8 percent over the medium term, underpinned by sustained high levels of external
support. The projection for FY2011/12 is based on modest recoveries in tourism and
remittance receipts, significant levels of budget support to finance government expenditure,
9
and high levels of construction activity financed by the EXIM loans.5 The medium term
projections assume that some fiscal consolidation will occur as EXIM-financed activities
wind down, that the government will increase the proportion of capital expenditure in its
budget, and that development partners will continue to provide substantial levels of grants.
The projections also assume that further progress will be made with the structural reform
agenda (including ensuring that public enterprises operate on a more commercial footing), and
that demographic trends will remain unchanged (including the relatively high emigration
rate).
25. Achieving more robust growth over the medium term will be a challenge, but
Tonga has the potential to meet it. The key sources of growth it can harness are those where
it can command premium prices to cover the higher production costs endemic to small,
remote economies – as from natural resource rents in tourism and fisheries. Tonga‟s tourism
sector has considerable untapped potential, which recent policy commitments by the GoT
with respect to Tonga‟s largest hotel (a public enterprise) may help to unlock. Tonga‟s
agricultural exports could receive a boost from new heat treatment and fumigation facilities,
helping Tonga overcome non-tariff barriers in key nearby large markets. Improving the
efficiency of the public enterprises that provide infrastructure services could also benefit
households and businesses, as could further efforts to reprioritise government expenditure
towards higher priority areas. In addition, Tonga could work to foster private sector
development in areas that can capitalise on government and donor expenditure – for instance,
building local private sector capacity for road maintenance. Further expanding access to
temporary labour programs abroad would also provide a boost to the domestic economy.
While cost-benefit analysis on work to reconstruct parts of Nuku‟alofa after the earlier civil
disturbances and to improve the road network on the main island under the EXIM loans is not
available, investments such as these might be expected to have some positive impact on
economic growth over the medium term. Tight domestic credit conditions are likely to
continue to hamper growth, however, for as long as the major banks remain focused on
rebuilding their balance sheets.
26. While the fiscal situation facing Tonga is challenging, the GoT is committed to
fiscal consolidation over the medium term, as part of a concerted effort to rebuild its
fiscal space to respond to future economic shocks. The deficit (after grants) is budgeted to
fall to 1.7 percent of GDP in FY2011/12, as a result of continued restraint on government-
funded expenditure and increased levels of grant support from development partners. The
GoT has taken an appropriately conservative approach to its revenue forecasts in FY2011/12,
and is holding government-funded expenditure at about the same nominal level as the
previous year („government-funded expenditure‟ refers to government expenditure other than
donor-financed project expenditure and EXIM-financed capital expenditure and lending).6
Given the inflation outlook, this involves a cut in real expenditure of about 5.8 percent. The
GoT aims to achieve this without compromising core functions and services by reprioritising
its resources, including protecting spending on health and education and ensuring sufficient
resource allocations for the ministries dealing with the productive sectors of the economy. For
5 While the EXIM-loan financed construction activity does add to Tonga‟s GDP figures, it has a very limited
impact on the rest of the economy. The expatriate labour force does not add significantly to domestic demand, but is resident in Tonga sufficiently long for its activities to be included in GDP calculations. 6 Reflecting donor project expenditure and capital expenditure and lending activity associated with the EXIM
loans, total expenditure and net lending in FY2011/12 is budgeted to fall by 2.9 percent.
10
the medium term, the GoT is continuing to take a conservative approach to revenue forecasts
and is planning to keep government-funded expenditure approximately constant in real terms.
27. Budget support grants from development partners will remain critical for Tonga
over the medium term. In FY2011/12, the GoT is likely to receive nearly 40 million pa‟anga
in budget support grants (15.1 million from the Bank, 12.8 million from the EC, 8.9 million
from AusAID, and 3 million from NZ-IDG). This is equivalent to 23.3 percent of
government-funded expenditure, and reduces the overall budget deficit from 6.6 percent of
GDP to 1.7 percent of GDP. The size and sequencing of these grants will enable the GoT to
close the financing gap for the government-funded budget and rebuild cash balances to a level
where the GoT no longer has to engage in cash rationing, thereby improving the prospects for
effective budget execution not only this year but also over the medium term. The restoration
of a solid level of cash balances this year will enable the GoT to have confidence in planning
its expenditure on essential public services and capital projects over the medium term. Led by
the Bank, coordination among development partners with respect to the size and sequencing
of budget support over the medium term is critical to Tonga‟s fiscal stability. For FY2012/13,
the Bank has indicated that it could provide a budget support grant of approximately 8.4
million pa‟anga, with a possible 8.7 million from Australia and a possible 5.9 million from the
EC. In FY2013/14, Australia and the EC may be in a position to provide similar amounts of
budget support (with the Bank yet to confirm whether it will provide budget support).
28. Two large loans in recent years have raised Tonga‟s debt levels above policy-
dependent thresholds, placing the country at high risk of debt distress. With a combined
face value of about 30 percent of GDP, the reconstruction and roads loans from China‟s
EXIM Bank have resulted in a rapid increase in external debt. The 2011 Debt Sustainability
Analysis (DSA) for Tonga estimates that the PV of external debt will stand at 38.1 percent of
GDP in FY2011/12, well above the policy-dependent threshold of 30 percent. Tonga‟s debt
and debt servicing also breach the relevant debt-to-export and debt service-to-export ratios for
prolonged periods. Although the modified thresholds that take into account Tonga‟s
remittance receipts do not affect the assessment of its level of debt distress, these do indicate
that Tonga‟s high and relatively stable remittances provide it with a valuable cushion,
reducing liquidity risks. Debt breaches the debt-to-exports-and-remittances threshold for a
much shorter period than it does the unmodified threshold, while debt service does not breach
the debt-service-to-exports-and-remittances threshold during the projection period. Stress tests
show the vulnerability of Tonga‟s debt position to a slowdown in exports or a significant
depreciation in its currency (which, given the renminbi denomination of the EXIM Bank
loans, is a major risk), even when remittances are considered. The DSA concludes that, taking
into account the cushion provided by remittances, Tonga‟s projected debt profile is consistent
with manageable – if high risk – debt dynamics.7
29. The GoT is committed to returning its debt to sustainable levels, through both
prudent fiscal policy and an effective debt management strategy. Because Tonga is
assessed as being at high risk of debt distress, the Bank and the Fund have been advising the
GoT to avoid taking on new public or publicly-guaranteed debt, even on concessional terms.
In its FY2011/12 budget statement, the GoT has articulated this commitment to avoid any
further external borrowing over the medium term, even on concessional terms, in order to
7 Despite the rise in total debt, the GoT has continued to reduce its domestic debt level – to an estimated 5
percent of GDP as at June 2011, relative to about 20 percent of GDP at the beginning of the last decade.
11
regain the fiscal space needed to respond to future shocks. It has also stated its commitment to
use domestic borrowing only to cover short term cash shortfalls. During its time in office, the
new government has demonstrated these commitments in practice. The GoT has also decided
to develop a debt management policy, to complement its existing debt policy, and has been
receiving technical assistance for this from PFTAC during 2011. (Selected economic
indicators of Tonga‟s medium-term macroeconomic outlook are set out in Table 2.)
30. The macroeconomic policy framework in place is adequate and suitable for the
purposes of this operation, but is subject to uncertainty. A sharper than expected rise in
global commodity prices would exacerbate inflation and threaten the incipient economic
recovery in Tonga. The global fallout of possible developments in the European debt crisis
and in the US economy could yield a further shock for Tonga‟s remittance flows, which poses
a threat both to growth and fiscal stability. The macroeconomic policy framework also
depends on the continued availability of grants from development partners over the medium
term, given Tonga‟s high risk of debt distress and hence the inadvisability of borrowing to
fund fiscal deficits. Even significant delays in budget support would threaten fiscal stability.
In addition, any large unanticipated increases in the civil service wage bill would cause the
deficit to widen substantially. There is also a risk that the new government will not be able to
withstand pressure to undertake new policy initiatives beyond those approved in the budget.
Finally, Tonga remains vulnerable to a variety of natural disasters, events that may also place
considerable stress on the macroeconomic policy framework.
III. THE GOVERNMENT‟S PROGRAM AND PARTICIPATORY PROCESSES
31. Tonga‟s national development strategy is set out in the Tonga Strategic
Development Framework, 2011–2014 (TSDF), which was endorsed by the new
government in May 2011. The extensive consultation process underpinning the TSDF began
under the previous government. Individual line ministries worked interactively with their
stakeholders, including both civil society groups and private sector entities, over a period of at
Table 2: Summary of Medium-Term Macroeconomic Outlook
FY09 FY10 FY11 FY12 FY13 FY14
Output and prices
Real GDP -0.1 -0.5 1.2 1.7 1.8 1.8
Consumer prices (period average) 5.0 2.0 6.0 5.8 - -
Central government finance
Total revenue and grants 29.8 28.2 24.2 27.0 21.0 20.2
Tax revenue 19.5 17.1 15.3 14.1 14.1 13.2
Non-tax revenue 3.4 4.0 2.5 3.1 3.0 2.8
Project grants 6.9 5.8 3.3 4.9 1.3 2.2
Budget support grants 0.0 1.4 3.0 4.9 2.7 1.9
Total expenditure and net lending 29.6 33.8 31.6 28.6 22.5 21.7
of which EXIM 0.6 4.3 7.7 3.9 - -
Overall balance 0.1 -5.6 -7.5 -1.7 -1.5 -1.5
Total financing -0.1 5.6 7.5 1.7 1.5 1.5
External financing (net) -0.1 3.6 6.9 3.1 - -
Domestic financing (net) 4.7 2.0 0.5 -1.5 - -
Privatisation receipts -4.7 0.0 0.0 0.0 - -
External debt
External debt 31.1 35.3 42.0 43.1 44.2 43.3
Memorandum item:
Nominal GDP 663.2 681.4 752.9 810.2 856.8 924.7
Source: World Bank, International Monetary Fund, and Ministry of Finance
(annual percentage change)
(percent of GDP)
(percent of GDP)
(millions of pa'anga)
12
least one year, in preparing their strategies for contribution to the TSDF process. The Ministry
of Finance and National Planning then led the coordination process within government,
whereby line ministries worked together to integrate their sector-specific strategies into a
single national development strategy. The TSDF was approved by Cabinet at a special
meeting convened for the purpose in May 2011.
32. The vision guiding the TSDF is to develop and promote a just, equitable and
progressive society in which the people of Tonga enjoy good health, peace, harmony and
prosperity, in meeting their aspirations in life. To achieve the vision of the TSDF, the GoT
aims to deliver on nine strategic objectives.
33. The first objective is to build strong, inclusive communities by engaging local-
level groups in meeting their service needs and ensuring the equitable distribution of
development benefits across and within communities. Protection and support is to be
provided to vulnerable communities and vulnerable groups within communities – including
women, the elderly and youth – especially unemployed youth. Rural and outer-island
communities are to be supported through community-specific development programs that are
implemented in conjunction with the communities themselves.
34. The second and third objectives concern the role of a dynamic public and private
sector partnership in driving economic growth, and the importance of adequate
infrastructure for business activity and household wellbeing. Under the second objective,
the GoT will work to ensure that public sector policies and services create an enabling
environment in which the private sector can flourish, including through the maintenance of
macroeconomic stability. Emphasis is placed on the key industries of tourism, agriculture,
fisheries and temporary labour abroad. Under the third objective, the GoT is committed to
implementing its National Infrastructure Investment Plan, which is a medium-term plan for
energy, telecommunications, water, solid waste management and transport infrastructure.
35. The fourth, fifth and sixth objectives focus on key aspects of human development. Under the fourth objective, the GoT aims to strengthen educational standards, particularly by
improving the quality of the universal basic education it provides. Under the fifth objective,
the GoT aims to improve the technical and vocational education and training available to
Tongans, to enable them to take advantage of employment opportunities both in the domestic
labour market and in labour markets abroad. Under the sixth objective, the GoT is committed
to the provision of quality, effective and sustainable health services, with a particular focus on
health promotion and on tackling the growing incidence of non-communicable diseases.
36. The seventh, eighth and ninth objectives concern governance. Under the seventh
objectives, the GoT aims to integrate cross-cutting concerns relating to Tonga‟s distinctive
culture, fragile environment and vulnerability to natural disasters and the impacts of climate
change, into all government programs. Under the eighth objective, the GoT is committed to
adhering to the principles of good governance, accountability, transparency and the rule of
law, in order to improve the governance of Tonga at this critical juncture in its political
history. Under the ninth objective, the GoT aims to strengthen the operation of the judiciary
and to maintain law and order to ensure a safe, secure and stable society.
37. The delivery of these objectives is to be facilitated by four „enabling themes‟ on
the public sector, macroeconomic framework, public enterprises and development
13
assistance. The efficiency and effectiveness of the public sector is to be improved, by
focusing on core functions, optimising the use of resources, improving service delivery and
improving coordination. On the macroeconomic framework, the TSDF emphasises the
importance of good fiscal management, including effective revenue collection and sound
public expenditure management. On public enterprises, further reforms are planned to
improve their accountability and sustainability and to accelerate the privatisation agenda. On
development assistance, the TSDF stresses the value of a coordinated approach to Tonga‟s
relationship with development partners. Each enabling theme in the TSDF is underpinned by
a set of specific strategies, which are themselves allocated to particular ministries to
implement.
38. The proposed operation will help to sustain the momentum of key public sector
and economic reforms in Tonga, in support of the objectives and enabling themes of the
TSDF. The public financial management reforms in the proposed operation will support the
objective of good governance, particularly with respect to accountability and transparency, as
well as the enabling theme on good fiscal management. The fiscal policy reforms will bolster
the enabling themes on good fiscal management and the efficiency and effectiveness of
government. The structural reforms will support the private sector and infrastructure
objectives, as well as the enabling theme on public enterprises. And the social protection
reforms will contribute to the first objective, of building strong, inclusive communities.
39. The proposed operation was developed through a very strong dialogue between
the Bank and the GoT. This included consultation with all relevant authorities, both within
the central government and at the sector-specific level. With specific reference to public
financial management and fiscal policy reforms, this included the key central agencies at the
administrative and political level. With respect to structural reforms, this included the relevant
government agencies and – on the electricity and petroleum reforms – Tonga Power Limited
and the Tonga Competent Authority, respectively. On social protection, this included an array
of relevant government agencies as well as civil society institutions and people from a
selection of villages in different parts of Tonga.
IV. BANK SUPPORT TO THE GOVERNMENT‟S PROGRAM
LINK TO COUNTRY ASSISTANCE STRATEGY
40. The World Bank Group‟s Country Assistance Strategy for the Kingdom of Tonga,
FY2011–2014 (CAS) is built around three themes of reform, integration and resilience. The first theme is supporting policy reform to strengthen economic growth prospects and to
improve service delivery. The second theme is generating opportunities through greater global
and regional integration. The third theme is building resilience against shocks. The proposed
multi-year programmatic series of operations contributes mainly to the first theme of
engaging with the GoT on policy reforms to strengthen growth and improve service delivery. It supports policy actions aimed at strengthening critical aspects of public financial
management as well as key components of fiscal policy that underpin the delivery of services,
including revenue effort, expenditure quality and control of the civil service wage bill. The
actions also support essential structural reforms, including in the vital energy sector, in public
enterprise reform and in private sector development. The actions also contribute to the third
14
theme on building resilience against shocks, through the implementation of a social protection
mechanism.
41. The CAS provides scope for a multi-year programmatic series of operations to
respond to the aftermath of recent economic shocks and to underpin an agreed program
of reforms. The CAS envisages that the provision of budget support will depend on the new
government‟s commitment to continue work to strengthen public financial management,
improve revenue collection and expenditure prioritisation, and pursue structural reform. These
goals are reflected in the TSDF and the policy actions supported by the proposed operation.
42. The proposed operation will be complemented by analytical work under the CAS
theme of economic policy reform. The policy dialogue underpinning the proposed operation
grew out analytical work on macro-fiscal issues by the Bank in late 2010, in conjunction with
the Ministry of Finance. The Bank will take the public expenditure analysis component of this
work further in 2011, through technical assistance to help the Ministry of Finance with a
medium-term expenditure mapping to guide the realignment of resources with priorities.
COLLABORATION WITH THE IMF AND OTHER DONORS
43. The World Bank and the IMF maintain a close working relationship on Tonga,
and engage in an ongoing dialogue on a range of macroeconomic and structural issues. The Bank has participated in the last three Article IV missions, facilitating the discussions on
fiscal policy and structural reform in particular. The Bank and the Fund jointly prepare the
Debt Sustainability Analysis each year for Tonga. Based on this cooperation, the Bank and
the Fund share a common view about Tonga‟s macroeconomic and structural reform
priorities.
44. The Bank cooperates closely with key development partners in the provision of
analytical work and technical assistance to Tonga. ADB and PFTAC staff informally peer-
reviewed the Bank‟s macro-fiscal analysis in late 2010. The Bank‟s technical assistance on
the medium-term expenditure mapping in late 2011 also involves close consultation with the
ADB and PFTAC, including as the work to the ADB‟s technical assistance on a medium-term
budget framework and PFTAC‟s technical assistance on a tax policy and administration
review. In addition, Bank and ADB staff will participate in the PFTAC-led tax review.
45. The Bank has led efforts to coordinate development partners in the provision of
budget support to Tonga. The Ministry of Finance has taken a firm stand in favour of donor
coordination and requested the Bank to lead the coordination on the donor-side, in recognition
of the strength of the dialogue between the Bank and the GoT on economic policy as well as
the energy sector. Early in 2011, the Bank began a dialogue with the GoT and development
partners on the policy actions that might be associated with budget support, culminating in
agreement on a joint policy matrix. The ADB, AusAID, EC, PFTAC and NZ-IDG are all
supporting the implementation of the matrix, through varying combinations of budget support
and technical assistance. In recognition of their value, the GoT is now taking steps to
institutionalise the joint dialogue on economic policy and the associated reform program.
RELATIONSHIP TO OTHER BANK OPERATIONS
46. The World Bank Group is significantly scaling up analytical and financial
support for Tonga, to help Tonga mitigate the constraints of economic geography and
15
make the most of the opportunities available to it. There is room for the Bank to provide
USD 50 million in IDA funds in FY2011–2014, significantly more than the USD 33 million
provided since Tonga joined the Bank in 1985. Structured around the CAS themes, the Bank‟s
engagement includes investments in energy, telecommunications and transport, a post-
tsunami reconstruction program, and analytical work and technical assistance on labour
migration and remittances, education standards, social protection and climate change
resilience.
47. The proposed operation builds on the Bank‟s Energy Sector Development Policy
Operation, undertaken in late 2010. The earlier operation helped the critical energy sector
reform program to remain front and centre of the policy agenda in Tonga during the transition
to a new government. The cornerstone of the operation was its support for the Tonga Energy
Road Map (TERM), which the GoT adopted in August 2010. The TERM is a landmark
energy sector policy, developed through unprecedented cooperation between the GoT and its
development partners, laying out a least cost approach and implementation plan to reduce
Tonga‟s vulnerability to oil price shocks and achieve an increase in quality access to modern
energy services in a financially and environmentally sustainable manner. The proposed
operation will help to take the previous operation forward, by supporting the GoT as it
undertakes the next key policy actions needed to implement the TERM.
48. The proposed operation will complement the TERM Implementation Project
being developed by the Bank. The Bank is also proposing an investment project to help the
GoT implement the TERM, joint funded by IDA and the Pacific Region Infrastructure
Facility (PRIF). A project identification mission took place in May 2011. The proposed
project will assist with: the reform of the legislative and regulatory framework for the energy
sector; the establishment of baseline data and a monitoring framework; the design,
establishment and seed funding of a green energy incentive fund; and the preparation of the
electricity provider for the integration of renewable energy supplies. The proposed operation
will complement this investment project, by supporting critical policy and regulatory reforms
in the energy sector.
LESSONS LEARNED
49. The proposed operation reflects key lessons learned from the two development
policy operations that the Bank has undertaken in the Pacific Islands. Budget support is a
relatively new modality for Bank operations in the Pacific, but has proven successful thus far.
The proposed operation draws lessons from the Samoa Economic Crisis Recovery Support
Credit in mid 2010 and the Tonga Energy Sector Development Policy Operation in late 2010.
50. Development policy operations can be quickly mobilised and achieve good results
in the context of strong reform momentum. In both the Samoan and Tongan operations,
budget support needed to be mobilised relatively quickly, with the Bank‟s ability to respond
facilitated by strong government ownership of a reform agenda. In the case of Samoa, the
reform agenda was broad, and substantive and realistic policy actions that could be supported
within short timeframes were readily identifiable. In the case of Tonga, the government had a
deep commitment to a sector-specific reform agenda, which formed a ready foundation for the
operation. In both cases, the Bank‟s engagement provided momentum at a time when the
reform agendas could have gone off-track due to the multiple challenges then facing the
governments. For the proposed operation, the GoT has a strong commitment to a broad
16
reform agenda. Bank engagement has assisted the GoT to clarify and sequence its reform
program, and will provide momentum to implement the reforms in a challenging fiscal
context.
51. Project-level engagement can assist in identifying key priorities to be supported
through policy operations. Both the Samoan and Tongan operations demonstrated how prior
project engagement can provide a vital foundation for identifying key policy reforms that can
drive further progress in important sectors, assisting the implementation of the reforms, and
tracking progress closely with relatively little additional monitoring effort. The leveraging of
project and technical assistance engagements for policy programs is being repeated in the
proposed operation in respect of the energy sector and the social protection actions.
52. Close coordination and engagement with other development partners in the
identification of policy priorities is useful in sectors where the Bank has limited
knowledge and engagement. The Samoan and Tongan operations reflected the general
context of Bank engagement in the Pacific Islands, that the Bank does not have sufficient
presence to maintain in-depth knowledge of all sectors across all countries. In key sectors
where the Bank did not have active project or policy engagement, task teams drew selectively
on analytical work and advice from other development partners to quickly build knowledge
and make judgments regarding policy priorities across a broad range of sectors. In the
proposed operation, the task team worked very closely with other development partners to
help identify possible reform areas and to gather background information and experience to
judge potential actions, particularly from the ADB in the area of public enterprise reform.
53. Coordinated management of international aid flows, in the context of prudent
fiscal policy, can provide vital support in mitigating the impacts of external shocks in the
Pacific Islands. Without the aid flows provided to Samoa and Tonga to help them respond to
the shocks they were facing, the impacts of these shocks would have been more extensive and
prolonged. Development assistance played a vital role in financing essential government
services, while maintaining macroeconomic stability. These operations demonstrated the
importance of coordination between macroeconomic policy and international aid flows in
managing economic shocks, a lesson that is equally applicable to the proposed operation in
Tonga, given the continuing effects of the shocks Tonga has experienced in recent years.
ANALYTICAL UNDERPINNINGS
Public Financial Management Reform
54. Performance indicators of public financial management in Tonga have shown an
improvement in recent years. In the 2007 Public Expenditure and Financial Accountability
(PEFA) assessment, Tonga received 16 satisfactory ratings out of the 27 applicable indicators
(taking a rating of at least „C‟ as satisfactory). In the 2010 PEFA assessment, the number of
satisfactory ratings increased to 20, and there were also improvements in the ratings within
the satisfactory category. Reflecting tax policy and administration reforms, marked
improvements were noted on the transparency of taxpayer obligations and liabilities, and the
effectiveness of measures for taxpayer registration and tax assessment. Improvements were
also noted for orderliness and participation in the annual budget process, the effectiveness of
controls on payroll and non-salary expenditure, and the timeliness of accounts reconciliation.
17
55. The 2010 PEFA highlighted several weaknesses in public financial management
(PFM), which will be tackled over the course of the proposed multi-year programmatic
series of operations. The coverage of in-year budget reports was identified as an area for
improvement, because the existing reports could not be used to compare actual and forecast
revenues and expenditures, weakening control of budget execution. Public access to key fiscal
information was found to be limited, in part because the budget proposal is made public only
when it is approved, not when initially submitted to the legislature, and in-year budget reports
are not made public. The process for legislative scrutiny of the budget was also found to be
inadequate. Budget credibility was found to be weak at a disaggregated level, with significant
variances in the composition of the outturn resulting from the shifting of resources between
ministries during the year through the „Contingency Fund‟. Significant weaknesses were
found in the external audit process, in the scope, nature and follow-up of the external audit,
and in legislative scrutiny of audit reports. Weaknesses were also identified in the chart of
accounts, arrears collection, and timeliness of submissions of the annual financial statements.
56. A PFM assessment by PFTAC in 2010 provides further clarity on weaknesses
and guidance on the appropriate sequencing of PFM reforms. In the assessment, PFTAC
lays out the PFM building blocks that need strengthening in Tonga as a foundation for the
planned introduction of a medium-term budget framework (MTBF). These include
consolidating bank accounts, automating bank reconciliations and moving towards a Treasury
Single Account (TSA), as well as improving the clarity and uniformity of application of the
chart of accounts. Improved revenue, expenditure and cash flow forecasting is recommended,
along with better monitoring of budget execution and more frequent consultations on
execution with ministries. PFTAC also identifies the pressing need to strengthen planning
processes in line ministries and the links between plans and the budget, and to control the use
of the Contingency Fund.
Fiscal Policy Reform
57. The Bank‟s macro-fiscal analysis provides guidance on an appropriate approach
to revenue reforms in Tonga. The analysis indicates that the recent decline in tax revenue is
consistent with the adverse impact of the global economic crisis on remittances and the end of
the domestic credit bubble on corporate taxes, as well as the coincidental timing of the
completion of Tonga‟s tax reforms (the commencement of which a few years earlier had
temporarily boosted tax revenue). The analysis highlights a limited number of changes made
to the tax regime in response to the global food and fuel price crisis that would also have
reduced tax revenue, for the GoT to reconsider at an appropriate juncture. Weaknesses in
compliance could not be ruled out, but were beyond the scope of the analysis. On the basis of
the analysis, tax revenues can be expected to recover in line with the recovery of remittances.
Further analysis would be required to suggest whether changes to tax policy or administration
are warranted to increase tax collection beyond what such a recovery is expected to deliver.
That further analysis and its reform recommendations form part of the proposed operation.
58. The macro-fiscal analysis also provides guidance on an appropriate approach to
expenditure reforms in Tonga. The GoT has responded to shortfalls in tax revenue in recent
years by holding government-funded expenditure constant in nominal terms, translating into
significant real reductions. The GoT has protected education and health spending from across-
the-board restraints, but the restraints have otherwise been detrimental to the composition of
expenditure. Expenditures that can be deferred or reduced – such as purchases of goods and
18
services, maintenance and operations, and capital expenditure – have been, hampering service
delivery and threatening higher future costs. The proportion of the government-funded budget
going to wages and salaries increased, in part because of an across-the-board salary rise in
FY2009/10 agreed prior to the recognition of the decline in revenues. The analysis shows the
necessity of controlling the civil service wage bill to protect complementary inputs to service
delivery in a flat budget environment, and of intensifying efforts to reprioritise resources to
core functions and services. Both of these areas of work form part of the proposed operation.
Structural Reform
59. The TERM lays out a strategy to reduce Tonga‟s vulnerability to oil price shocks
and achieve an increase in quality access to modern energy services in a financially and
environmentally sustainable manner. The related analytical work traces the implications of
oil price volatility for electricity prices, and the implications of rising oil prices and energy
demand for the viability of renewable energy sources for the grid. The analysis demonstrates
the need for a comprehensive reform of the legislative, regulatory and institutional framework
applying to the energy sector – including updating the regulatory framework for the electricity
supplier to ensure its incentives are aligned to those of consumers in least cost energy sources.
60. Two studies by the Bank on the petroleum sector identify existing weaknesses in
the regulatory structure and supply chain for petroleum, and lay out a series of reforms
to remedy these weaknesses.8 The studies show that around 90 percent of Tonga‟s energy
needs come from imported petroleum products. Fluctuations in underlying fuel prices impose
the biggest cost, with transport and storage costs imposing additional, but more limited, costs.
The overarching recommendation is to prioritise reforms to strengthen the petroleum
regulatory regime, improve the competitive environment and increase energy security.
Several phases of reforms are recommended, in order to ensure that Tonga is better protected
from volatility in world oil prices and that fuel costs in Tonga reflect efficient costs of supply,
storage and distribution. In addition, reforms to the regulatory regimes for petroleum are
recommended, to enable the benefits of these reforms to be passed on to consumers.
61. The ADB has played the lead role among development partners on analytical
work and technical assistance on public enterprise reform in Tonga. Tonga‟s portfolio of
14 public enterprises currently includes 8 infrastructure service providers and 6 enterprises
engaged in commercial activities, with a combined asset value the equivalent of about 40
percent of GDP (in FY2008/09). The ADB‟s latest benchmarking study of the performance of
public enterprises in the Pacific, Finding Balance, shows that Tonga‟s public enterprises
outperform those of the other Pacific Islands in the study, with an average return on equity
between FY2001/02 and FY2008/09 of 6 percent and an average return on assets of 3.6
percent. Tonga has also set the pace for public enterprise reform, including through legislative
reforms, strengthened governance frameworks, restructuring of boards, and the rationalisation
and privatisation of public enterprises. Public enterprise reforms have slowed in the last year,
due to the difficulty involved in the next phase of reforms, which requires the consolidation of
existing reforms and further progress on the rationalisation and privatisation agenda.
8 The first study, The Regulation of Tonga’s Petroleum Sector, was completed by the Bank in June 2010. The
second study, Tonga Oil & Gas Supply Chain Efficiency & Price Stabilisation, was completed by the Portland Group for the Bank, also in June 2010.
19
62. Analytical work by the International Finance Corporation (IFC) and the ADB
has highlighted areas of Tonga‟s business licensing system that are in need of reform. The IFC, in its 2009 study Reviewing the Business Licence in Tonga, reviews and provides
recommendations on the reform of the general business licence process and the nine activity-
specific business licences that operate in Tonga. The extent of the reform needed for the
different licences vary, but one general finding is that administrative resources are unduly
focused on issuing licences, at the cost of enforcing compliance with the terms of licences.
Licensing is frequently used as an enforcement tool for performance and compliance, when
other means could be more cost effective and less burdensome to the majority of businesses.
The ADB‟s recent Private Sector Assessment reinforces the message about the need to reform
business licensing. A comprehensive reform plan that deals with the entire system and
incorporates work to strengthen cost-effective enforcement mechanisms is needed.
Social Protection
63. The Social Protection Issues Paper prepared for the Ministry of Finance by the
ADB shows that basic needs poverty in Tonga has risen over the last decade, and that
there are significant gaps in Tonga‟s social protection framework. The paper analyses the
results of the 2009 Household Income and Expenditure Survey (HIES), to show the increase
in basic needs poverty since the 2001 HIES (see Table 3). The analysis shows poverty to be
highest outside Nuku‟alofa on the main island, Tongatapu, but to have risen most sharply on
Tonga‟s other islands. While the proportion of women with expenditure below the basic needs
poverty line is quite similar to the population averages in each region, the incidence of
poverty among children is notably higher. The paper highlights that a significant portion of
the population lives just above the basic needs poverty line, thus a small event could push
many more households below the poverty threshold. On Tonga‟s social protection framework,
the paper shows that the GoT provides good access to basic education and health and gives
annual grants to a number of non-government organisations that provide social services to the
disadvantaged. However, formal social protection programs are limited to the public service
contribution-based pension scheme. The paper list options for other formal programs the GoT
could consider, and outlines the processes required to introduce such programs in future.
Table 3: Poverty Incidence in Tonga by Region, 2001 and 2009
Percentage of Households/Population With Expenditure Below the Basic Needs Poverty Line
Households Population Disaggregation (2009)
2001 2009 2001 2009 Women Children
National Average 12.2 16.4 16.2 22.5
Nuku’alofa 13.7 14.7 18.0 21.4 22.3 25.8
Rest of Tongatapu 14.4 17.5 18.8 23.5 23.8 29.4
Other Islands 9.0 17.0 11.8 22.9 23.0 29.9 Source: Ministry of Finance (Tonga Department of Statistics and 2009 HIES)
V. THE PROPOSED ECONOMIC RECOVERY OPERATION
OPERATION DESCRIPTION
64. The proposed operation is the first in a multi-year programmatic series of
operations, the first a single tranche grant of USD 9 million equivalent and the second a
single tranche grant of USD 5 million equivalent. The proposed multi-year programmatic
20
series of operations will assist the GoT to implement key aspects of its medium-term reform
agenda, while providing a predictable flow of resources in a challenging fiscal environment.
The four key components of Tonga‟s development agenda that will be supported by the multi-
year programmatic series of operations are: strengthening public financial management;
strengthening fiscal policy; promoting structural reform; and improving social protection.
65. A multi-year programmatic series of operations will help to sustain the
momentum of the public sector and economic reforms the GoT plans to implement over
the medium term, and provide a strong signal of the Bank‟s commitment to its
engagement in Tonga. The GoT has established clear medium-term goals for a number of
key public sector and economic policies, and laid out the incremental steps needed to achieve
those goals. Through its strong policy dialogue with the GoT, the Bank has assisted the GoT
to shape and sequence this reform agenda. In some areas, it is not yet possible to specify in
precise terms the subsequent steps the GoT will need to take to achieve its policy goals, but
the direction of these subsequent steps is clear – as is the commitment of the GoT to proceed
with them. The proposed multi-year programmatic series of operations is an appropriate
reflection of the scope and strength of the Bank‟s dialogue with the GoT. The GoT sees Bank
support for its multi-year reform agenda as an important aspect of that agenda, because it will
help to sustain the momentum of reform efforts, enable the GoT to continue to benefit from
the Bank‟s advice and assistance as it progresses with the reforms, and provide a predictable
flow of resources to the GoT over the period that it is implementing the reforms.
66. The policy actions for the first operation and triggers for the second operation
have been selected because they cover key aspects of the GoT‟s medium-term reform
agenda. The GoT is committed to implementing this broader reform agenda, with the selected
actions acting as focal points for that implementation process. On PFM, the broader reform
agenda covers strengthening PFM building blocks, increasing the credibility of the budget,
strengthening budget execution, and increasing the transparency of key budget processes.
Under fiscal management, the reform agenda covers strengthening revenue effort, improving
expenditure quality, and improving management of the civil service wage bill. Within the
sphere of structural reform, the reform agenda encompasses energy sector reform, public
enterprise reform and private sector development. The reform agenda also includes the
development of a community-based social protection mechanism. The selected prior actions
for the first operation and triggers for the second operation are summarised in Table 4, with
the GoT‟s broader medium-term reform matrix presented in Annex 5. The decision to proceed
with the second operation will be based on an evaluation of the triggers outlined in the current
operation. This evaluation will be a bottom line assessment, meaning that as long as most
triggers are on track, the Bank will proceed with the preparation of a second operation.
67. At the request of the GoT, the Bank has taken the lead in coordinating the
dialogue with key development partners, in support of a joint policy matrix. In practice,
this has meant that the Bank has worked with the GoT on the one hand, and with other
development partners on the other hand, to build up a policy matrix that could secure
consensus. With development partners, this work has proceeded through regular group audio
conferences and email correspondence, supplemented by a number of bilateral engagements,
particularly with AusAID and NZ-IDG, and also more recently with the EC, whose budget
support operation is at an earlier stage of development. The GoT and development partners
are firmly committed to the medium-term policy goals that drive the matrix. Within that
overarching framework, development partners have shown considerable flexibility with
21
respect to the precise actions that are feasible in particular policy areas, in order to put their
support behind a matrix that has strong government ownership. This same flexibility should
ensure that a similar approach is taken to refining the actions for the second operation.
POLICY AREAS
Strengthening Public Financial Management
68. The GoT has made a clear commitment to strengthen the building blocks of its
PFM system, increase the credibility of the budget, strengthen budget execution, and
increase the transparency of key budget processes. This PFM reform agenda has been
articulated in the FY2011/12 budget, and supports the enabling theme in the TSDF on good
Table 4: Prior Actions and Triggers
Prior Actions – First Operation* Triggers – Second Operation
Strengthening Public Financial Management
1. The Recipient has instituted an in-year budget reporting
system that tracks key budget information on a monthly and
quarterly basis to strengthen budget execution.
2. The Recipient has reformed the budget calendar so as to
make budget proposals available to the public when tabled
in the Recipient’s Legislative Assembly, in order to improve
transparency in the process for adopting the budget.
1. The Recipient makes the quarterly budget reports available
to the public in a timely manner, to improve the
transparency of budget execution.
2. The Recipient tables all outstanding annual reports from the
Auditor-General in the Legislative Assembly, to improve the
transparency of the audit process.
Strengthening Fiscal Policy
3. The Recipient has brought recruitment in all parts of the
public service under centralised control and has applied a
partial hiring freeze in the Recipient’s fiscal year 2011-2012
to improve the management of the public service wage bill.
3. The Recipient will implement reforms recommended by the
tax policy and administration review, in order to improve
revenue collections over the medium term.#
Promoting Structural Reform
4. The Recipient has approved guiding principles for reforming
the electricity tariff structure, aimed at a financially
sustainable and efficient electricity sector, taking into
account the planned shift to renewable energy, with
adequate protection for the poorest consumers.
5. The Recipient has amended the petroleum pricing templates
in general accordance with the recommendations of the
independent reviews of said templates, in order to ensure
that consumer prices are an accurate reflection of existing
costs.
6. The Recipient has published the audited accounts of the
designated major public enterprises in order to improve the
transparency of the financial management of said
designated major public enterprises.
4. The Recipient will implement a new electricity tariff that, inter alia, provides for full cost recovery, establishes
financial incentives to generate and distribute electricity
efficiently, and institutes a lifeline tariff.
5. The Recipient will amend the regulatory framework for the
petroleum sector to, inter alia, define the regulated assets of
petroleum suppliers, institute systems to independently
value and inspect the regulated assets of petroleum
suppliers, and establish a system of shared supplier
shipping among petroleum suppliers.
6. The Recipient will bring the International Dateline Hotel to
the point of transaction, as recommended by an
internationally-reputable transaction adviser.
Improving Social Protection
7. The Recipient has adopted a community public works
program targeted to poor and vulnerable communities.
7. The Recipient will complete the pilot of the community public
works program, and will take into account lessons learned
for scaling up the program.
*The supporting documentation that will be used to verify the successful completion of the prior actions for the first operation is listed in Annex 4. #The precise measures to be taken under this action will be firmed up prior to the preparation of the second operation.
22
fiscal management. This agenda responds to weaknesses identified in the 2010 PEFA and in
PFTAC‟s recent PFM assessment. On PFM building blocks, the GoT has been consolidating
its bank accounts to improve cash management, and revising the chart of accounts to increase
its clarity and to reduce redundant and duplicate codes. On budget credibility, the GoT has
been strengthening the links between the plans of line ministries and the budget, and working
to reserve use of the Contingency Fund for the purposes defined in the PFM Act.9 The
reforms to strengthen budget execution and increase the transparency of the budget process
are prior actions for the proposed operation. (For an overview of the GoT‟s progress on this
wider PFM reform agenda, see Annex 5.)
First Operation
Prior Action 1: The Recipient has instituted an in-year budget reporting system that tracks
key budget information on a monthly and quarterly basis to strengthen budget execution.
69. The fiscal difficulties that the GoT has been experiencing in recent years have
exposed weaknesses both in the tools available for the effective monitoring of budget
execution, and in the extent of attention paid to those tools within government. While the
GoT has been producing monthly revenue and expenditure forecasts, this has been for cash
management purposes, not budget monitoring purposes. Similarly, while the GoT has been
producing in-year budget reports, these have reported on actual revenues and expenditures
without comparing those to forecast revenues and expenditures. In addition, the reports have
not been produced frequently and have not been finalised in a timely manner – though the
financial system is capable of timely compilation of all revenue and most expenditure data.
Thus, the government has been without an analytical tool for identifying, explaining and – if
need be – remedying any major divergences from the approved budget, in a timely manner.
The GoT has also been without an analytical basis for internal dialogue on the state of budget
execution. The reports that have been produced have not been used to brief Cabinet, removing
the opportunity to help create demand for in-year budget monitoring at the political level.
70. The GoT sees the value of producing and deliberating over monthly and
quarterly in-year budget reports that compare actual revenues and expenditures with
forecast revenues and expenditures and provide explanations of the identified
divergences. The GoT has been tracking key budget information and producing these reports
from the beginning of FY2011/12. To date, the reports have been of high quality and have
provided both the data and the analysis necessary to assess all key financial aspects of the
execution of the budget – including highlighting issues that need to be addressed to tackle
identified weaknesses in budget execution. As well as information on revenues, expenditures
and balances, the reports contain other information of importance to the GoT, including on
any transactions involving the Contingency Fund and any unbudgeted expenditures. Each
report is distributed to line ministries as a basis for consultation at the level of senior officials,
to help direct attention across the whole of government to budget execution. Each report is
also provided to Cabinet, as a briefing on the status of budget execution. Over time, it is
hoped this will help create demand for the reports at the political level, helping to
institutionalise the process. The Bank provided technical assistance to the GoT to build
consensus on the format of the reports, build capacity to complete good quality reports, and
strengthen the wider budget monitoring systems to which the reports contribute.
9 Given the existence of adequate systems for budget formulation, this operation does not focus on that aspect of
PFM. (The 2010 PEFA rated Tonga at a „B‟ for orderliness and participation in the annual budget process.)
23
Prior Action 2: The Recipient has reformed the budget calendar so as to make budget
proposals available to the public when tabled in the Recipient’s Legislative Assembly, in
order to improve transparency in the process for adopting the budget.
71. The recent constitutional changes in Tonga that have led to governments being
chosen by members of the Legislative Assembly – the majority of whom are elected – has
opened the way for a new era of transparency. One area where the GoT is committed to
increasing transparency is in PFM, beginning with the budget process. In the past, the annual
budget has been made public only after it has been approved by the Legislative Assembly. In
practice, Cabinet has had very little time to consider the budget proposal before introducing it
to the Legislative Assembly and has tended to treat the budget proposal as the Ministry of
Finance‟s draft, rather than as its own budget proposal. In the absence of access to the actual
budget proposal, civil society groups and the general public have not been able to engage in a
debate surrounding its contents. It has also not been possible for them to distinguish between
the budget as proposed by Cabinet and the budget as approved by the Legislative Assembly.
72. The GoT has decided to improve the transparency of the budget process, by
making Cabinet‟s budget proposal available to the public when it is tabled in the
Legislative Assembly. This is a critical reform to increase the transparency of the budget
process. It also signals the transition the GoT intends to make to a system where Cabinet is
more actively involved in the preparation of the budget and takes ownership for it when
submitting it to the Legislative Assembly. This decision by the GoT involves amending the
budget calendar to provide more opportunity for Cabinet to deliberate over the budget
proposal during its preparation from the FY2012/13 budget cycle onwards. Increased Cabinet
ownership of the budget should have a related effect of reinforcing the centrality of the budget
to resource allocation and planning, helping to strengthen the credibility of the budget.
Second Operation
73. As a trigger for the second operation, the GoT will make the quarterly budget
reports available to the public in FY2012/13, to improve the transparency of budget
execution. The transparency and accountability yielded by this action will help further
strengthen budget execution, including by reinforcing the demand for effective in-year budget
monitoring. The sequencing of these reforms provides the GoT with an important learning
opportunity in FY2011/12, to improve the forecasting of revenues and expenditures, the
quality and timeliness of the in-year budget reports, and the mechanisms used to remedy any
problems identified. Development partners have indicated interest in supporting the budget
literacy of civil society groups and other bodies with potential interest in the reports, including
the Public Accounts Committee (PAC).
74. As a further trigger for the second operation, the GoT will table all outstanding
annual reports from the Auditor-General in the Legislative Assembly, to improve the
transparency of the audit process. This action will help to strengthen Tonga‟s audit process
by increasing its transparency and by improving its timeliness – which is a vital component of
its effectiveness. At the same time as the GoT works to clear the backlog of annual reports
from the Auditor-General under the second operation, the GoT will also work to ensure that it
submit its annual financial statements (AFS) to the Auditor-General and gazettes the audited
public accounts on time, to help improve the overall timeliness of key audit processes.
24
Expected Outcomes
75. Over the medium term, the reforms supported by the proposed multi-year
programmatic series of operations are expected to improve the credibility of the budget
and increase public access to key fiscal information. On budget credibility, the measure
chosen as a monitoring indicator is the composition of the expenditure outturn relative to the
approved budget (PEFA Indicator 2). In conjunction with the wider PFM reforms being
undertaken by the GoT, improving budget monitoring through the in-year reporting system is
expected to strengthen budget execution and – through that – bring actual outturns closer to
the approved budget. Over the last decade, the GoT‟s performance on PEFA Indicator 2 has
been a 0–5 percent deviation in four years, a 5–10 percent deviation in three years, and a 10–
15 percent deviation in three years (equivalent to a „C‟). The medium term target is to reduce
deviation to 0–5 percent in most years (a „B‟). On public access to key fiscal information,
PEFA Indicator 10 has been chosen as a monitoring indicator. To date, the public has had
timely access to only one of the six specified key budget documents comprising the indicator
(equivalent to a „C‟). The medium term target is to increase this to three documents (a „B‟).
Strengthening Fiscal Policy
76. The GoT places a high priority on reforms to increase its revenue effort, improve
the quality of its expenditure, and strengthen its management of the public service wage
bill. The GoT has articulated its fiscal policy reform agenda in the FY2011/12 budget, in
support of the TSDF enabling theme on good fiscal management. This agenda corresponds
with challenges identified in the macro-fiscal analysis undertaken by the Bank, in conjunction
with the Ministry of Finance, in late 2010. On revenue, the GoT is now working with PFTAC
on a comprehensive review of Tonga‟s tax policy and administration, to identify opportunities
to increase revenue over the medium term. On expenditure, the GoT is currently working with
the Bank on a comprehensive review of its expenditure, to map out an allocation of resources
over the medium term that is more aligned with the GoT‟s priorities. The reform to strengthen
management of the public service wage bill is a prior action for the proposed operation.
First Operation
Prior Action 3: The Recipient has brought recruitment in all parts of the public service
under centralised control and has applied a partial hiring freeze in the Recipient’s fiscal
year 2011-2012 to improve the management of the public service wage bill.
77. The fiscal difficulties that the GoT has been experiencing in recent years have
exposed weaknesses in the management of the public service wage bill. The GoT is taking
an appropriately cautious approach to addressing the challenges of its wage bill, because
public service conditions have been a source of social unrest in the past. With government-
funded expenditure remaining flat in nominal terms in recent years, however, attention has
been focused on how inadequate control over the wage bill has contributed to a squeeze in
non-wage expenditure. Between FY2008/09 and FY2010/11, the wage bill as a proportion of
government-funded expenditure (excluding debt payments) rose from 41.6 percent to 58.0
percent.10
A key driver of the wage bill over this period was a 10 percent wage rise in
10
These figures are used to convey the trend only. They are not useful for international comparisons because they consider the wage bill as a share of government-funded expenditure, overstating the wage bill share of
25
FY2009/10, which had been agreed previously as part of a major wage settlement – with the
prevailing fiscal situation not affecting its implementation. In July 2011, Cabinet agreed there
would be no across-the-board or sector-specific wage rises in FY2011/12 or FY2012/13 – a
significant measure in itself, given inflation rates.11
A second key driver of the wage bill over
this period has been a performance increment that adds 3-4 percent to the wage bill each year.
This increment does not work particularly well in managing and rewarding performance, but
the GoT does not see this as an opportune time to address it. A third key driver of the wage
bill is recruitment. Some categories of public servants (for instance, police and prison
officers) could be recruited without approval from the Ministry of Finance. Even for
ministries subject to the authority of the Public Service Commission (PSC), which does
consult the Ministry of Finance on the availability of funds before authorising recruitment,
adequate measures have not been in place previously to prevent recruitment of non-essential
personnel.
78. The GoT has now brought recruitment in all parts of the public service under
centralised control, and has applied a partial hiring freeze in FY2011/12 to improve the
management of the public service wage bill. All ministries, whether or not subject to PSC
authority, now require approval from the Ministry of Finance for any recruitment.12
Ministries
not subject to PSC authority are now subject to Cabinet-approved recruitment ceilings. This
will improve the management of the wage bill and enable an overarching fiscal perspective to
be applied to wage bill control. Under authority from Cabinet, the Ministry of Finance, in
consultation with PSC, has defined a process for all ministries to follow to obtain exceptions
to the hiring freeze for essential personnel. This has included specifying the criteria that will
apply to determine an essential position. These include defining the lowest nine grades of the
public service – just over one quarter of existing staff – as non-essential and, within the upper
grades, allowing recruitment only where a position is critical to the delivery of a core service
and where not filling the position will result in tangible shortcomings in service delivery.
Ministries seeking an exemption to the hiring freeze must submit a case that their proposed
recruitment is for an essential position, as defined by the given criteria, to the PSC and
Ministry of Finance for consideration. The decision of the Ministry of Finance is final. These
measures should enable the Ministry of Finance, in conjunction with PSC, to apply the partial
hiring freeze effectively. The GoT expects that the partial hiring freeze will help to realign its
personnel with its policy priorities, by allowing redeployment of existing personnel to fill
vacancies in essential areas, allowing recruitment of essential personnel in priority areas, and
allowing attrition to reduce the number of staff in non-essential roles and in non-priority
areas. In the absence of an analytical basis for specifying a particular ceiling on the aggregate
number of new hires during FY2011/12, the above approach was thought by the Bank and the
GoT to be the most appropriate way of controlling recruitment at this point in time.
79. Centralised control of recruitment in all parts of the public service and the
partial hiring freeze are expected to serve as key components of the GoT‟s capacity to
keep the actual wage bill in line with the budget for FY2011/12. The budget for
FY2011/12 was based on no across-the-board or sector-specific pay rises, the continuation of
aggregate expenditure by excluding donor project expenditure (primarily non-wage current and capital expenditure). 11
While a wage comparator survey in Tonga is not available to validate the appropriateness of this measure, the 60–70 percent wage increase in FY2005/06 and FY2006/07, agreed as part of the wage settlement after the strike in FY2005/06, together with the 10 percent wage rise in FY2009/10, suggest that it is likely to be reasonable. 12
PSC already took the step of abolishing long-term vacant posts in FY2008/09.
26
the performance increment, and the partial offsetting of a Cabinet-endorsed new recruitment
of teachers by centralising control of recruitment in all parts of the public service and the
operation of the partial hiring freeze. In FY2010/11, the budget provided for a 4 percent
increase in the wage bill on the budget for the previous year, whereas the actual wage bill
grew 14 percent on the actual for the previous year. It will, therefore, be an important
achievement if the GoT is able to keep the actual wage bill for FY2011/12 in line with the
budget forecast, which represents an increase of approximately 3 percent on the actual for
FY2010/11. In the context of the current challenging fiscal circumstances, enabling the GoT
to control the wage bill in FY2011/12 in this way – and prevent it from squeezing out other
expenditures – is the key objective of this policy action. It is supported by a complementary
measure in FY2011/12 preventing ministries from viring funds from non-wage to wage
expenditure. The partial hiring freeze will also serve as a useful interim measure as the GoT
embarks on a broader restructuring of the public service over the medium term, to consolidate
ministries with a view to increasing their focus on their core functions and improving the
effectiveness and efficiency of government. The controls encompassed in the partial hiring
freeze – in particular the way it is designed to help the GoT realign personnel with policy
priorities – will provide a foundation for this broader restructuring objective. It is expected
that the temporary partial hiring freeze will – when informed by a series of functional reviews
– be transformed into a more permanent arrangement for establishment control that will
enable the GoT to fully align its personnel with its policy priorities. The GoT and the Bank
have engaged in some preliminary discussions about possible technical assistance from the
Bank in support of broader public service reforms, including on establishment and payroll
control, performance management, and public sector restructuring.
Second Operation
80. As a trigger for the second operation, the GoT will implement the reforms
recommended by the tax policy and administration review, in order to improve revenue
collections over the medium term. Improving revenue collections to the extent feasible will
be an important factor in easing the fiscal constraints the GoT is currently facing, and will
support both fiscal consolidation and debt sustainability. The GoT is firmly committed to
increasing its revenue effort, and is willing to be guided by the PFTAC-led review – to which
the Bank is contributing – on the most appropriate ways of doing this. The first round of
reforms will be implemented in the FY2012/13 budget, and will serve as a trigger for the
second operation. While the precise measures to be taken under this action will be firmed up
before the second operation, in light of the specific recommendations of the PFTAC-led
review, the GoT‟s commitment to this reform and the direction of this reform action are
already clear. The preliminary indications from the review are that there is indeed scope to
increase revenue collections over the medium term, from a combination of policy measures
(mainly with respect to reducing import duty, excise and consumption tax concessions at the
border and strengthening the policy regime for non-wage personal income) and compliance
measures in both the tax and customs administrations.
Expected Outcomes
81. Over the medium term, the reforms supported by the proposed multi-year
programmatic series of operations are expected to enable the GoT to keep its actual
wage bill in line with the budget and to increase tax revenue collections. With respect to
the wage bill, the monitoring indicator chosen is the variation between the actual wage bill
27
and the budget. Over the last decade, this has averaged approximately 3.7 percent (excluding
the year of the civil service strike and major wage settlement). The medium term target is to
reduce this variation to below 2.5 percent. A monitoring indicator for tax revenue collections
will be added under the second operation, when the precise measures to be taken have been
firmed up (preliminary indications are that there is scope to increase revenue collections).
Promoting Structural Reform
82. The GoT has a wide-ranging structural reform agenda, within which the energy
sector plays a leading role. The reform agenda for the energy sector is articulated in the
TERM, which supports the infrastructure objective of the TSDF. The other main components
of the structural reform agenda are guided by the TSDF enabling theme on public enterprise
accountability, sustainability and privatisation, and the TSDF objective on a dynamic public
and private sector partnership to drive economic growth. On energy, the GoT is establishing a
clear locus of management for the energy sector within a single government agency. The GoT
is also reforming the electricity tariff and implementing reforms to the petroleum sector, both
of which are prior actions for the proposed operation. On public enterprises, the GoT is
improving the transparency of public enterprise finances, which is also a prior action for the
proposed operation. And on the private sector, the GoT is formulating a medium-term reform
strategy for the business licensing system and the wider business environment. The focus of
the prior actions on structural reform reflects the Bank‟s view that energy sector and public
enterprise reforms are critical to Tonga‟s economic and social development – with a bigger
potential impact at the current juncture than general business climate reforms.
First Operation
Prior Action 4: The Recipient has approved guiding principles for reforming the electricity
tariff structure, aimed at a financially sustainable and efficient electricity sector, taking
into account the planned shift to renewable energy, with adequate protection for the poorest
consumers.
83. The proposed operation builds on the earlier Energy Sector Development Policy
Operation in key ways. Under the earlier energy operation, the Bank supported the adoption
of the TERM. Under the TERM, Tonga aims to reduce its reliance on diesel for electricity
generation, through a combination of efficiency improvements and the development of
domestic renewable energy alternatives to diesel for electricity generation. The GOT intends
to mobilise private sector know-how and investment, where possible, through the
establishment of independent power producers using renewable energy and connected to the
electricity grid. Under the current structure of the electricity tariff, however, Tonga Power
Limited (TPL) does not have a strong incentive to integrate energy from cost-effective
renewable sources, because it can pass on the full cost of the diesel it uses to consumers. The
TERM envisages an initial phase of grant-funded public-private partnerships, to pilot grid
integration and give TPL the opportunity to learn how to manage the economic despatch of
diesel electricity in conjunction with renewable electricity sources. The GoT is now entering
that pilot phase, and the regulatory framework needs to be adjusted to accommodate it.
84. The current electricity tariff is not entirely consistent with a financially
sustainable and efficient electricity sector, taking into account the planned shift to
renewable energy, or with the provision of protection to the poorest consumers. Because
28
TPL can fully recoup its diesel costs through electricity tariffs, it lacks a strong incentive to
buy electricity from cost-effective renewable suppliers. Incentives to minimise the cost of its
petroleum imports or use its diesel inputs efficiently could be strengthened. In these
circumstances, it is difficult for the GoT to have full confidence in the efficiency of TPL‟s
operations. In addition, the existing electricity tariff does not provide any protection to the
least-well off electricity consumers, in the form of a lifeline tariff or similar fully-funded
community service obligation. The absence of any protection for the poor militates against
allowing oil price rises to be passed on in electricity tariffs, particularly in times of hardship.
The pass-through of oil price rises is also more difficult to justify if TPL does not have
sufficiently strong incentives to make its operations as efficient as possible. If oil price rises
are not passed on in tariff increases, however, TPL‟s operations are no longer financially
sustainable, posing a risk that essential maintenance and capital investments will not be
undertaken, and much larger costs will be faced in future. As a wholly government-owned
enterprise, this places a significant financial risk on the GoT. This kind of situation was faced
earlier this year, when the GoT was unwilling to allow a fully-cost recouping increase in the
electricity tariff, given the hardship already being faced by households and communities.
85. Recognising the weaknesses of the existing electricity tariff, the GoT has
approved the guiding principles for reforming the electricity tariff structure, aimed at a
financially sustainable and efficient electricity sector, taking into account the planned
shift to renewable energy, with adequate protection for the poorest consumers. In calling
for the existing tariff to be reformed, Cabinet has explicitly recognised its key weaknesses, as
described above. The guiding principles for the reform approved by Cabinet direct how the
tariff is to be redesigned to overcome these weaknesses. The incentives in the electricity
sector will be realigned to be consistent with the GoT‟s policy of improving efficiency and
diversifying away from diesel-only electricity generation. In line with the TERM, the reform
will also provide a way to accommodate costs incurred by TPL to promote energy efficiency
and demand management. The structure of the tariff will be amended to provide protection for
the poorest consumers, for the first time. By improving the efficiency and equity of the sector,
these reforms will provide a firm foundation for GoT to have confidence in the sector,
reducing the risk that tariffs will not be allowed to adjust to achieve full cost recovery in
future, thereby undermining the financial sustainability of the sector. Work to reform the
electricity tariff will involve a review of the precise means by which the existing tariff needs
to be adjusted to comply with the principles endorsed by Cabinet. Cabinet has approved that
the findings of this review will be made publicly available. The GoT will then adopt a new
tariff, in accordance with the guiding principles for the reform. In the view of the Bank, the
fact that Cabinet has endorsed a set of guiding principles that clearly direct how the structure
of the electricity tariff is to be reformed over the next year is a very strong policy action.
86. TPL is well placed to be a strong partner in the proposed reforms. Its financial
position has improved over the period since it returned to public ownership, with a small loss
of 0.7 million pa‟anga in 2009 being followed by a modest net profit of 3 million pa‟anga in
2010. Overdue receivables are now maintained at 11 days, an excellent performance. Absent
further interventions in the full cost-recovery of tariffs, its ten-year business plan shows that it
has the capacity to reinvest at appropriate level while remaining financially viable. Since its
return to public ownership, TPL has also been successful in undertaking physical, technical
and administrative reforms that have resulted in reduced system losses at power stations,
transmission, distribution and billing points. Losses in its main system have fallen from 17–18
percent in late 2010 to 14 percent in late 2011 – a very respectable result and one nearing the
29
regulated target system loss of 13 percent. This has been achieved through programs to
upgrade generators, repair connections and insulators, replace meters and reform the billing
system. Plans to install capacity in renewable energy, beginning with a 1 MW solar plant, will
be facilitated through the Bank‟s proposed TERM Implementation Project, which will provide
for a coordinated approach to installing renewable capacity to ensure that least cost options
are prioritised and that system management adjusts efficiently to the new intermittent supply.
Prior Action 5: The Recipient has amended the petroleum pricing templates in general
accordance with the recommendations of the independent reviews of said templates, in
order to ensure that consumer prices are an accurate reflection of existing costs.
87. Petroleum sector reforms are needed to reduce costs in the petroleum supply
chain, strengthen the competitive environment, improve the safety of petroleum assets,
and increase energy security. Specific reform actions to achieve these goals have been
identified by two recent studies by the Bank.13
The recommended reforms include the
implementation of fuel price hedging to improve petroleum price risk management and reduce
the volatility of fuel prices suffered by energy consumers, the introduction of shared oil
supplier shipping to Tonga to reduce transport costs, and independent reviews of fuel
company operations and facilities to verify the standards of the facilities and to audit the cost
components and asset values that feed into the fuel pricing templates. The studies also
recommend independent reviews of the LPG and petroleum pricing templates themselves, to
increase the transparency of the templates and provide a basis for adjusting the templates to
ensure that consumer prices are an accurate reflection of existing cost structures. In addition,
the studies recommend a broader review of the regulatory framework for petroleum, to
provide regulatory requirements and contractual incentives for fuel companies to improve
their efficiency and pass on savings to consumers. On the basis of the findings of the Bank‟s
studies, the GoT has formulated and approved an action plan to guide its implementation of
the recommendations of the studies over the medium term. This action plan has been endorsed
by Cabinet, signalling the seriousness with which these reforms are being taken. As well as
adjusting the pricing templates in response to the independent reviews, progress on the action
plan to date has included TPL piloting a hedge on a significant proportion of its fuel
purchases, which is a vital step in reducing Tonga‟s exposure to oil price rises and volatility.
88. The GoT has now conducted independent reviews of the LPG and petroleum
pricing templates, and adjusted the templates in general accordance with the
recommendations of the reviews.14
This is an important signal of the GoT‟s commitment to
regulate the petroleum sector effectively and transparently. It is also an important action in
itself to ensure that consumer prices accurately reflect the existing costs of petroleum supply.
It offered an immediate improvement in the regulatory system that could be implemented
prior to the wider regulatory review, because it represents a discrete component of the system.
The independent reviews made recommendations to adjust prices in line with the operational
costs of suppliers, as per their most recent audited accounts, and also made recommendations
to adjust the structure of the retailers‟ margin. The GoT has now adopted all of these
recommendations, adjusting the pricing templates accordingly. The retailers‟ margin had been
13
See „Analytical Underpinnings‟. 14
These pricing templates enable the price of petroleum products to be set in Tonga, using an import parity pricing model that is commonly used for oil products in other countries. The templates effectively translate the fluctuating world price for refined petroleum products into regulated fuel prices in Tonga that reflect delivery and other operating costs, using a building block approach.
30
set on a percentage basis, which had imposed a significant penalty on consumers during
periods of high oil prices. It is now set on a per litre basis, yielding a significant saving to
consumers. The only recommendation of the independent reviews that the GoT did not adopt
was to raise the fuel quality standard. The GoT does not wish to impose this additional cost on
consumers at this juncture, but will reconsider the recommendation in future, particularly if
the margin between the cost of lower and higher quality fuels continues to narrow. Thus, in
the context of this action, „in general accordance‟ means that the GoT has adopted and
implemented all of the recommendations of the independent reviews, with the exception of
the recommendation pertaining to the fuel quality standard. This adjustment of the pricing
templates is a key step in the incremental process of reforming the petroleum sector.
Prior Action 6: The Recipient has published the audited accounts of the designated major
public enterprises in order to improve the transparency of the financial management of the
designated major public enterprises.
89. Achieving further improvements in the performance of public enterprises will
help to reduce the costs and improve the quality of key infrastructure services in Tonga. In recent years, the GoT has made progress with public enterprise reforms geared at moving
public enterprises onto a more commercial footing.15
A critical aspect of the GoT‟s reforms to
date has been strengthening the regulatory framework for public enterprises. In late 2010, the
Public Enterprise Act was amended to impose a commercial objective on public enterprises,
enhance the commercial governance practices of public enterprises, strengthen the monitoring
framework for public enterprises, clarify the rules and processes associated with the approval
of community service obligations, establish clear guidelines on the selection and appointment
of directors, and clarify director accountabilities. The GoT has also been restructuring public
enterprises, with a view to privatising the ones that are not infrastructure service providers.
90. In a significant step forward for the transparent financial management of public
enterprises, the latest audited accounts of six major public enterprises have now been
made available to the public. The GoT expects that this transparency initiative will help to
improve the accountability and the sustainability of public enterprises over time, in line with
the TSDF. This is the first time that the audited accounts of public enterprises have been made
publicly available, in line with a new requirement enacted as part of the recent legislative
reforms. Bringing six major public enterprises into compliance with this new legislative
requirement represents a significant action on the part of the new government, which has
made the strategic choice to prioritise this transparency measure early in its terms of office.
This publication is the end product of significant preliminary work to prepare the accounts of
the public enterprises and have them audited in a timely manner. The six major public
enterprises whose accounts have now been published are Tonga Power Limited, the Tonga
Water Board, Tonga Airports Limited, the Ports Authority of Tonga, Tonga Post Limited and
the Tonga Development Bank. These six major public enterprises now serve as examples of
financial transparency for the smaller enterprises in the portfolio.
Second Operation
91. As a trigger for the second operation, the GoT will implement a new electricity
tariff that, inter alia, provides for full cost recovery, establishes financial incentives to
15
For the financial status of Tonga‟s public enterprises, see the „Analytical Underpinnings‟ section.
31
generate and distribute electricity efficiently, and institutes a lifeline tariff. The Bank will
be engaged in this process, both through its involvement in the preceding review and through
its support for the implementation of the new tariff under the proposed TERM
Implementation Project. Through this project, the Bank will be able to provide TPL with any
technical assistance it may require to implement the new tariff, including assistance with any
further upgrades to its metering and billing capacities and any analytical work required to
enable TPL to effectively target the poorest electricity consumers.
92. As a further trigger for the second operation, the GoT will amend the regulatory
framework for the petroleum sector to, inter alia, define the regulated assets of
petroleum suppliers, institute systems to independently value and inspect the regulated
assets of petroleum suppliers, and establish a system of shared supplier shipping among
petroleum suppliers. This action represents a further important step in the incremental
process of reforming the petroleum sector. It is expected to result in cost reductions in
transport, storage and overheads that can be passed on to petroleum consumers. The Bank
specialists involved in the initial petroleum studies will maintain their dialogue with the GoT
during this next phase of the reforms, with further analytical work and technical assistance
being provided to facilitate the implementation of these reforms through the proposed TERM
Implementation Project.
93. In the area of public enterprise reform, the trigger for the second operation will
be bringing the International Dateline Hotel to the point of transaction. The GoT is in the
process of appointing an internationally-reputable transaction adviser for the International
Dateline Hotel. The poor performance of the International Dateline Hotel under an earlier
joint-venture arrangement has held back the development of the tourism sector in Tonga, as
the largest hotel in Nuku‟alofa and taking up a prime real estate position. The transaction
adviser appointed by the GoT will advise on the best way to structure the transaction (whether
outright sale or some other form of transaction), to optimise the interests of the GoT.
Expected Outcomes
94. Over the medium term, the program of structural reforms is expected to
safeguard the financial position of TPL, yield benefits to energy consumers, and result in
a more focused portfolio of public enterprises. In the energy sector, three monitoring
indicators have been chosen. The first is the cost recovery of electricity tariffs, with the target
being the maintenance of full cost recovery. The second is the efficiency of the electricity
sector, with the specific indicator being that TPL is despatching electricity from its lowest
cost sources first. The third is benefit sharing in the petroleum sector, with cost savings from
regulatory reforms passed on to consumers through the relevant pricing mechanisms. The
program of public enterprise reforms is expected to yield a public enterprises portfolio that is
more focused on infrastructure services.
Improving Social Protection
95. The GoT is acutely aware of the increased hardship that households in Tonga
have been facing in recent years, and is committed to alleviating that hardship to the
extent possible. The first objective of the TSDF is to build strong, inclusive communities by
engaging local-level groups in meeting their service needs and ensuring the equitable
32
distribution of development benefits across and within communities. The GoT‟s community
workfare program, a prior action for the proposed operation, supports this objective.
First Operation
Prior Action 7: The Recipient has adopted a community public works program targeted to
poor and vulnerable communities.
96. The GoT is conscious that the majority of communities in need have received
little government-sourced help since the onset of the recent decline in remittances. To the
extent that it has supported domestic economic activity, the loan-financed capital expenditure
in recent years has been concentrated mainly in Nuku‟alofa, through the location of most
construction work. However, this construction activity – which propped up GDP figures in
FY2009/10 and FY2010/11 – has had very few linkages to the domestic economy. The
support to domestic economic activity that has been provided by the donor-financed floor
under government-funded expenditure has also been concentrated mainly in Nuku‟alofa,
through the wages of public servants, although these will have been distributed more widely
through family networks. Tonga is one of the few countries in the Asia-Pacific region where
the incidence of poverty is increasing – and increasing sharply, with the proportion of people
living below the basic needs poverty line increasing by over one-third between 2001 and
2009. Despite the important role of social and community networks and a strong tradition of
mutual self-help in Tonga, the covariate nature of the recent economic downturn has reduced
the scope for mutual assistance to address the increased hardship of affected households as
many of the households face the same reduced-income situation. In earlier times, remittances
from abroad often acted as an insurance mechanism for downturns in household income. In an
environment of reduced remittance receipts, recourse to this insurance arrangement is by
definition very limited. There is a significant risk that increasing poverty among a large
section of the population, if left unchecked, may lead to a persistent breakdown in traditional
systems of mutual self-help.
97. The GoT has now approved a community public works program targeted to poor
and vulnerable communities. The GoT lacks an established means to alleviate the increased
levels of hardship that households and communities are facing. The assessment by the Bank is
that there is a strong case for immediate action to establish an interim measure for this
purpose. With technical assistance from the Bank, the GoT has now approved a community
public works program that is designed to provide grant funds to communities for labour-
intensive public works projects they propose. The project will involve technical support for
capacity building in communities, to assist with project selection and design. The projects will
contain wage-labour components, to enable the participation of the poorest individuals and
provide them with a temporary income support cash injection. In the immediate term, the
projects will result in the creation or improvement of an asset that is of value to the
community. In the longer term, the project will strengthen the ability of communities to
organise and tap into resources in times of need. Thus, the program will provide short term
relief for those in need and support long term poverty reduction, through community
empowerment and capacity. The program will involve a close partnership with local non-
government organisations for technical and institutional assistance, and will help the GoT to
have a formal safety net mechanism to reach people quickly in times of crisis and transfer
needed resources to them, to prevent irreparable losses. In this way, the GoT will have an
33
enhanced ability to react quickly to similar shocks of similar magnitudes, by having a ready-
made social safety net mechanism that can be tailored to respond to a specific shock.
98. The community public works program approved by the GoT is, in the view of the
Bank, the most appropriate response to the current hardship faced by households and
communities in Tonga. Access to land, social and community networks, and Tonga‟s
reasonably high GNI per capita among the Pacific Islands, makes levels of food poverty very
low (approximately 3 percent of the population, according to the 2009 HIES). Thus, measures
that require less preparatory work – like unconditional cash transfers – were not deemed
necessary by Bank specialists. Instead, the Bank and the GoT determined that it would be
appropriate to take the additional time needed to establish a community public works scheme,
in order to achieve the greater benefits available from community asset creation and the
associated community capacity building. This approach had the additional advantage of
establishing the capacity in Tonga to operate such a scheme for the first time, which could
then be scaled up more quickly in future in times of need. Over time, the program is intended
to have wide coverage – with approximately 20,000 workers participating (benefiting
upwards of 40,000 people, taking account of their families).
Second Operation
99. As a trigger for the second operation, the GoT will complete the pilot of the
community public works program, and will take into account lessons learned for scaling
up the program. The pilot will be in accordance with the design adopted by the GoT,
informed by the technical assistance of the Bank, including the targeting criteria built into the
design. In the pilot phase, it is expected that around 10–15 communities, including 1,000–
1,500 workers and being home to approximately 3,000–4,500 people, will be involved. The
GoT will take into account lessons learned from the pilot phase in formulating a concrete plan
of action for scaling up the program. The Bank will provide technical assistance to the GoT,
to help it finetune the design and implementation of the full scheme once the pilot is
complete. The Bank is also securing funding from the Japan Social Development Fund for the
implementation of the scheme, and is working with other interested donors for further
support.
Expected Outcomes
100. Over the medium term, this policy action is expected to result in incremental
employment and income generation and community asset creation in the targeted
communities. The monitoring indicator chosen at this stage is the extent of incremental
employment and income generation and community asset creation and/or rehabilitation.
VI. OPERATION IMPLEMENTATION
POVERTY AND SOCIAL IMPACTS
101. The proposed operation will provide vital grant support to the budget, in a very
challenging fiscal environment. The budget support will help the GoT to maintain the
provision of core services to the public, and to build up its cash balances in order to avoid the
impediment to effective budget execution imposed by cash rationing. Budget execution will
be further strengthened by the PFM reforms the GoT is pursuing, leading over time to more
34
effective service provision as resources are utilised as scheduled and as budgeted. Service
provision is also expected to be strengthened by the GoT‟s efforts to reprioritise expenditure
to core functions, including as a result of the Bank‟s medium-term expenditure mapping
work.
102. The reforms to strengthen public service wage bill management are not expected
to have an adverse impact on poverty in Tonga. While the reforms can be expected to lead
to a reduction in recruitment in FY2012/13, they will not lead to any lay-offs (reductions in
staff numbers will only be due to attrition). Recruitment will continue for essential personnel,
not only preserving some new labour market opportunities in the public sector but also
ensuring that the provision of core public services will not be interrupted. In addition, the
GoT‟s main rationale for improving its management of the wage bill is to protect non-wage
expenditures from being further squeezed in the flat budget environment, which will also
make a contribution to core service delivery through the availability of the necessary inputs.
103. It is not possible to state with certainty the social impact of measures by the GoT
to strengthen its revenue effort. The precise measures that the GoT will take as part of the
second operation will be informed by the specific recommendations of the PFTAC-led
review. However, preliminary indications are that administrative reforms to improve
compliance are likely to offer more scope to increase revenue than reforms to tax policy
(given that Tonga‟s recent tax policy reforms have yielded a regime regarded as among the
best in the Pacific).
104. The proposed operation will support the introduction of the first formal social
protection component of utility service provision in Tonga. One of the primary objectives
of reforming the electricity tariff is to build a lifeline tariff or similar measure to protect the
poorest consumers into the electricity sector. The measure is likely to be targeted by
consumption volumes, with a view to improving the affordability of basic levels of service for
the poor. It is not necessarily the case that the cost of the lifeline tariff will be borne by better-
off consumers, businesses and government entities (although this is one option). It may be
that cost savings from the new grant-funded solar plant or from hedging fuel purchases can be
used to fund the life-line tariff. The other changes made to the electricity tariff should result in
decreased tariffs relative to a business-as-usual scenario, as TPL is provided with incentives
to reduce the costs of its petroleum imports, increase the efficiency of its operations, integrate
cost-effective renewable sources of energy into the grid, and promote energy efficiency. Thus,
the pass-through of changes in oil prices, though more consistent than in the past, is likely to
be less detrimental to the poor than under the current structure of the electricity tariff.
105. The reforms to the petroleum sector supported by the proposed operation should
also have a positive social impact. The amendment of the petroleum pricing templates has
already resulted in reduced petroleum product costs to consumers in Tonga, and future
reforms to the regulatory framework to require and to provide incentives for fuel companies
to improve their efficiency, should result in further savings to consumers.
106. The transaction of the International Dateline Hotel, which is expected to follow
from the relevant trigger under the second operation, is likely to yield significant
benefits to Tonga. Under the earlier joint-venture arrangement, the International Dateline
Hotel has performed poorly, including operating significantly under-capacity. The transaction
leading to a successful operation is expected to have a significant positive impact on the
35
operation of the enterprise itself – including its employment – and of the sector in which the
enterprise has the potential to be a key driver of development.
107. The community workfare program will yield a mechanism for the GoT to
provide both short term relief of hardship and longer term poverty reduction. At
present, the GoT lacks a formal mechanism to provide assistance to the most vulnerable
groups in the population. Under the proposed operation, the GoT will introduce a scheme that
is designed to assist households to cope with the negative impact of the recent crises that have
affected Tonga, through a wage earning opportunity, helping to prevent them from falling
further into poverty. At the same time, communities will benefit from asset improvements and
empowerment – as the technical know-how delivered as part of the scheme improves their
ability to organise, plan and access resources in future times of need.
108. The community workfare program is expected to have wide coverage, of at least
30,000 people. Approximately 15,000 workers will directly participate in the scheme, which
at the household level represents between 30,000 and 60,000 people. The latest HIES data
will be used to identify the most vulnerable populations through geographic targeting. While
many of the poor and vulnerable are concentrated in Tongatapu, people in the outer islands
have also been especially hurt by the recent crises. The scheme is thus expected to have
beneficiaries from communities across the whole of Tonga, with communities in urban, peri-
urban as well as rural areas targeted for the project. The evidence shows that the crises have
had equally devastating effects on these populations despite the fact they face different
hardships (in urban and peri-urban areas access to own-produced food is difficult while in
rural areas access to basic non-food items and basic services is challenging).
ENVIRONMENTAL ASPECTS
109. The policy actions supported under the proposed operation would not have a
negative effect on Tonga‟s environment, natural resources or forests. The policy actions
supported under the proposed operation pertain to public financial management, fiscal policy,
structural reform and social protection. They do not bear directly on environmental risks.
IMPLEMENTATION, MONITORING AND EVALUATION
110. The existing institutional structure for aid management in Tonga will be used to
implement and monitor the policy actions supported by the proposed operation. The
Ministry of Finance will provide overall guidance for the budget support program, and will
assume overall responsibility for coordinating the implementation, monitoring and evaluation
of the proposed operation. The Ministry of Finance will also be ultimately responsible for
reporting progress and coordinating actions among other concerned government agencies.
111. Specific indicators that the Bank will monitor for the policy areas supported by
the proposed operation are set out in Annex 2. The Bank will work with the GoT to assess
progress implementing the policy actions supported by the proposed operation, and to monitor
the specific indicators associated with each of the policy areas. The Bank will also play a
coordinating among development partners, to ensure that there is a single process for
assessing the implementation of the policy actions and a single process for evaluating the
monitoring indicators. This will reduce the administrative burden on the GoT.
36
112. Through its ongoing dialogue with the GoT, the Bank will help to sustain the
linkages between the policy actions under the proposed operation and the progress of
the broader reform agenda that these policy actions are an integral part of. Through this
dialogue, the Bank will continue to work with the GoT as it implements its broader reform
agenda and takes its reform program further over time. The Bank will also play a role in
supporting the GoT as it seeks to coordinate the technical assistance provided by development
partners in support of its reform agenda. The dialogue will continue to draw on sector
expertise within the Bank, and to link sector projects – particularly in the area of energy – to
the GoT‟s broader public sector and economic reform agenda.
FIDUCIARY ASPECTS
Public Financial Management Environment
113. This assessment of the fiduciary environment in Tonga is based on the 2010
PEFA assessment, which indicated an improvement in Tonga‟s PFM systems over the
three years following the 2007 PEFA assessment. The number of satisfactory ratings
increased from 16 to 20 out of the 27 indicators, and there were also improvements in the
ratings within the satisfactory category. Satisfactory ratings were received on all indicators
and sub-indicators of budget credibility and budget comprehensiveness and transparency. It
should be noted that, once it has been approved by the legislature, the GoT publishes its
annual budget in a timely fashion. One of the policy actions supported by the proposed
operation is for the GoT to move to publishing the budget proposal, at the time it is put to the
legislature. Within policy-based budgeting and predictability and control in budget execution,
most indicators and sub-indicators were satisfactory, but some unsatisfactory ratings were
issued for aspects of the multi-year budget perspective, the effectiveness of tax collections,
procurement, and the effectiveness of internal audit. The weaknesses in the multi-year budget
perspective are not uncommon in thin capacity environments, where the focus is rightly
placed on the annual budget, while the weaknesses noted in the collection of tax payments
stemmed from particularities in timing of assessments and delays in the collection some large
arrears which are before the courts. The GoT has taken steps to address the weaknesses in its
procurement process, with the adoption of new procurement regulations in late 2010. On
internal audit, there remains some debate in the Pacific about whether resources are best
concentrated in external audit capacity, rather than split between internal and external audit. It
should also be noted that within the budget execution set, the GoT achieved a satisfactory
rating on predictability in the availability of funds for commitment of expenditures.
114. The 2010 PEFA indicated areas of weaknesses in accounting, recording and
reporting and in external scrutiny and audit, which the GoT is taking steps to address. Within the area of accounting, recording and reporting, unsatisfactory ratings were issued on
the availability of information on resources received by service delivery units and the quality
and timeliness of the AFS. Making improvements on accounting by service delivery units is
not a challenge that it is suitable for the GoT to address immediately, but the GoT has now
cleared the backlog in its AFS. More significant weaknesses were identified in each of the
aspects of external scrutiny and audit: the scope, nature and follow-up of external audit;
legislative scrutiny of the annual budget law; and legislative scrutiny of external audit reports.
The proposed operation is supporting the GoT‟s efforts to addressing the second area, and it is
envisaged that the first and third areas will be addressed under the second operation. Among
the other PFM reforms the GoT is undertaking, it is improving the chart of accounts and
37
reconciling its bank accounts, to improve cash management. It is also strengthening
legislative scrutiny of public finances, particularly through the new PAC.
115. Reflecting reform efforts over the last five years, Tonga‟s CPIA rating has
increased from 2.9 to 3.5, with Tonga‟s policy and institutional performance now above
average for IDA countries. Given these improvements, but acknowledging the identified
weaknesses and reforms still required in PFM, the overall fiduciary risk is rated as “High”.
This conclusion is based on the 2010 PEFA‟s assessment that the legal and regulatory
framework for PFM in Tonga provides a solid basis for budgeting, spending and
accountability, and on the GOT‟s commitment to continue to implement PFM reforms.
116. Opportunities to gradually reduce the fiduciary risk have been identified and
associated actions have been considered. A number of areas were identified and require
further improvement in order reduce the government‟s overall fiduciary risk to the moderate
level. One area for further reform highlighted in the PEFA is accountability and transparency
relating to external audit. It is envisaged that this area will be addressed under the second
operation. This would contribute to a reduction in the fiduciary risk, and demonstrates the
Bank‟s support for progress on this area of PFM reform.
Foreign Exchange Environment
117. There is no current IMF Safeguards Assessment of the NRBT, as Tonga has not
accessed IMF funds. The NRBT publishes its annual report, its audited accounts, and the
report of the independent auditors of those accounts. The FY2009/10 annual report has been
published and the audited financial accounts were unqualified. The NRBT has an established
Revaluation Reserve Account, which provides an additional buffer for any foreign exchange
losses and maintains foreign reserves composed of a basket of currencies, reducing the
sensitivity to exchange rate risk as movements of these currencies generally offset each other.
118. While there is no indication of substantial issues within the foreign exchange
environment, until an IMF Safeguards Assessment is concluded there is insufficient
information available to draw any substantiated conclusions, so the foreign exchange
risk must be rated as “High”.
DISBURSEMENT AND AUDITING
119. The disbursement measures proposed are to ensure that the grant funds
disbursed by the Bank are deposited in a dedicated account of the NRBT, and then an
amount equivalent to the grant is credited to an account of the government available to
finance budgeted expenditures. The grant will be disbursed according to IDA disbursement
procedures for development policy operations. The full grant amount of USD 9 million
equivalent will be disbursed against satisfactory completion of the specified policy actions as
listed in Table 3 and the GoT agreement as summarised in the letter of the development
policy, and is not tied to any specific purchases. Once the grant is approved by the Board and
becomes effective, the proceeds of the grant will be deposited by IDA in one tranche, at the
request of the Recipient, into a dedicated Foreign Currency Deposit Account at the NRBT.
120. Flow of funds (including foreign exchange) is subject to normal Financial
Management processes. It is not possible to track the ultimate use of the foreign exchange
38
provided by the development policy operation proceeds, but grant proceeds flow into a
dedicated Foreign Currency Deposit Account at the NRBT and from it to the budget of the
GoT, and are thus subject to normal PFM processes and NRBT procedures. By way of a
letter, the GoT will provide confirmation to the Bank when the grant amount has been
credited to a Local Currency Deposit Account used to finance budgeted expenditures.
121. The GoT will arrange a special audit of the dedicated Foreign Currency Deposit
Account established in the NRBT. The audit will cover the following: (i) the accuracy of the
summary of the transactions of this account, including accuracy of exchange rate conversions;
(ii) that this account was only used for the purposes of the operation and that no other
amounts were deposited into this account, including confirmation from corresponding bank(s)
involved in the funds flow; and (iii) that payments from this dedicated Foreign Currency
Deposit Account were in a timely manner (normally within 30 days of disbursement)
transferred to a Local Currency Deposit Account available to finance budgeted expenditure.
The audit will be provided to the Bank as soon as available, but not later than six months after
the last disbursement from the Association, and will be made publicly available in a timely
fashion.
RISKS AND RISK MITIGATION
122. The proposed operation carries five main risks, for which risk mitigation
strategies have been adopted. These risks relate to the thin capacity of the public sector, the
recent nature of Tonga‟s political reforms, the uncertain external economic environment, the
dependence of the macroeconomic framework on the continued availability of grants from
development partners, and Tonga‟s high vulnerability to economic shocks and natural
disasters. These risks and the associated risk mitigation strategies are described below.
123. The thin capacity and small size of the public sector in Tonga poses a risk for the
successful implementation of the policy actions supported by the proposed operation. Thin capacity is typical of public sectors in very small states like Tonga, where there are also
only a small number of civil servants relative to the tasks attaching to a national government.
These factors pose a risk that it may not prove possible for the policy actions supported by the
proposed operation to be implemented as successfully or as quickly as expected. This risk has
been mitigated through the design of the operation, which has involved a strong dialogue
through which the GoT and the Bank have carefully selected a limited number of policy
actions that are key priorities of the GoT. A balance has been struck between actions that are
more demanding on administrative resources and actions that are more demanding on political
resources. The GoT and the Bank have also discussed at length the implementation
requirements for each action, to ensure that expectations regarding the timeframes for
implementation are realistic. The risk has also been mitigated through the dialogue with other
development partners, which has involved mapping out complementary technical assistance
that development partners will provide to support the implementation of the policy actions.
An additional risk with respect to public sector capacity is that the public sector is about to
undergo a restructuring to consolidate ministries, which may involve a period of uncertainty
and disruption as the reforms occur. This risk is being mitigated through the Bank‟s dialogue
with the GoT, on appropriate ways to approach and sequence the restructuring process.
124. Thin capacity may pose a specific risk to the social protection component of the
program. The GoT has little background experience or established capacity in implementing
39
social protection schemes. A strength of the proposed community public works scheme is that
it will be implemented in conjunction with civil society organisations, where they have
experience, expertise or capacity of relevance to the scheme – for example in participatory
selection of community projects, financial literacy training, or community-level supervision.
This also poses a risk, however, because the success of the program will depend in part on the
capacity and commitment of these civil society partners. The GoT is yet to gain significant
experience in working with civil society partners in this way. The risk is being mitigated by
careful preparatory work by the GoT and specialists from the Bank in identifying, assessing
and building partnerships with relevant civil society organisations. It will also be mitigated
through the provision of capacity building for civil society partners as the scheme is
implemented. In addition, the Bank will provide the GoT with ongoing implementation
support, including in respect of managing its relationship with civil society partners.
125. Tonga‟s political system has been reformed only recently, thus it is not yet clear
how it would respond in the event of a major shock. Similarly, it is not yet clear the extent
to which the new government will be put under pressure to deliver immediate benefits to
constituents. This risk has been mitigated through the Bank‟s dialogue with the GoT on
macroeconomic policy issues, which has helped strengthen awareness of Tonga‟s
macroeconomic challenges and strengthen resolve to maintain an appropriate macroeconomic
framework. While it will be challenging for the GoT to improve the management of the public
service wage bill, the GoT has made clear that this is a key priority for it, and one that has an
important place in the medium term public sector reforms that the GoT plans. The risk has
also been mitigated through the design of the program, by ensuring that it contains a selection
of policy actions that are both critical to economic and social development and provide
immediate and tangible benefits to the people, particularly the least well-off – with the energy
and social protection actions vital in this respect.
126. Considerable uncertainty exists with respect to Tonga‟s external economic
environment. A sharper than expected rise in global commodity prices would exacerbate
inflation and threaten the incipient economic recovery in Tonga. The global fallout of possible
developments in the European debt crisis and in the US economy could also yield a further
shock for Tonga‟s remittance flows, which poses a threat both to growth and fiscal stability.
The GoT is attempting to mitigate these risks over the medium term by rebuilding the fiscal
space it has to respond to shocks. More immediately, if remittance flows are weaker than
anticipated, tax revenues will be lower than forecast and the GoT will face a larger financing
gap than it has budgeted for. Thus, the GoT has taken a conservative approach to forecasting
tax revenues, based cautious expectations about remittance flows, providing itself with some
comfort in the event that remittances remain depressed. But in the event of a serious near-term
shock to remittances, or to commodity prices, the GoT will not yet have built the fiscal space
needed to respond, and will require additional support from development partners. The Bank
has discussed this prospect in its dialogue with other development partners.
127. The dependence of Tonga‟s medium term macroeconomic framework on the
continued availability of grants from development partners poses a risk to the proposed
operation. Delays in the receipt of budget support grants from development partners during
FY2010/11 have exposed the vulnerability of budget execution in Tonga to the vagaries of
development partners‟ bureaucratic processes and decision-making systems. Budget support
grants are expected to be the equivalent of 23.3 percent of government-funded expenditure in
FY2011/12. The timing of the receipt of budget support will thus be critical to the GoT‟s
40
ability to execute its budget as planned and maintain the normal functioning of government.
Unanticipated delays may lead to cash flow problems and consequent cash rationing that will
not only impede government functions and services but divert the attention of officials and
policymakers from their medium-term reform agenda. This risk has been mitigated by efforts
led by the Bank, at the request of the GoT, to coordinate the support of development partners
for a joint, multi-year policy matrix. A single process for verifying progress against this
policy matrix should lead to a more predictable flow of budget support grants.
128. Tonga is highly vulnerable to external economic shocks and natural disasters. Such events may place undue stress on the macroeconomic policy framework if they
precipitate a widening of the fiscal gap. They may also undermine the implementation of the
GoT‟s reform agenda, if institutional resources need to be diverted to respond to these shocks.
The proposed operation helps to mitigate this risk over the medium term, by contributing
critical resources to support the budget in challenging fiscal circumstances. Over time, budget
support grants from development partners should provide the opportunity for the GoT to
rebuild its cash balances, improve its fiscal situation, and reduce its risk of debt distress,
thereby rebuilding the GoT‟s fiscal space to respond to future shocks.
41
ANNEX 1: LETTER OF DEVELOPMENT POLICY
42
43
44
ANNEX 2: TONGA: ECONOMIC RECOVERY OPERATION POLICY MATRIX
Policy Actions and Medium-Term Output/Outcome Indicators
Prior Actions – First Operation Triggers – Second Operation Output/Outcome Indicators
Strengthening Public Financial Management
1. The Recipient has instituted an in-year budget
reporting system that tracks key budget information on
a monthly and quarterly basis to strengthen budget
execution.
2. The Recipient has reformed the budget calendar so as
to make budget proposals available to the public when
tabled in the Recipient’s Legislative Assembly, in order
to improve transparency in the process for adopting the
budget.
1. The Recipient makes the quarterly budget reports
available to the public in a timely manner, to improve
the transparency of budget execution.
2. The Recipient tables all outstanding annual reports
from the Auditor-General in the Legislative Assembly,
to improve the transparency of the audit process.
The budget is credible at the level of disaggregated
expenditure, with the extent to which the variance
in the primary expenditure composition exceeds the
overall deviation in primary expenditure being 0–5
percent in most years (equivalent to a ‘B’ on PEFA
Performance Indicator 2).
Baseline: 0–5 percent (FY2006/07)
10–15 percent (FY2007/08)
5–10 percent (FY2008/09)
0–5 percent (FY2009/10)
5–10 percent (FY2010/11)
(equivalent to a ‘C’ on PEFA PI-2)
Public access to key fiscal information increases,
with at least three of the elements defined in the
PEFA criteria satisfied – annual budget
documentation, in-year budget execution reports
and year-end financial statements (equivalent to a
‘B’ on PEFA Performance Indicator 10).
Baseline: One element satisfied (FY2010/11)
(equivalent to a ‘C’ on PEFA PI-10)
Strengthening Fiscal Policy
3. The Recipient has brought recruitment in all parts of
the public service under centralised control and has
applied a partial hiring freeze in the Recipient’s fiscal
year 2011-2012 to improve the management of the
public service wage bill.
3. The Recipient will implement reforms recommended by
the tax policy and administration review, in order to
improve revenue collections over the medium term.*
The outturn for the government-funded public
service wage bill is within 2.5 percent of the budget
estimate.
Baseline: 3.7 percent average variation
(FY2000/01–FY2010/11, excluding
FY2005/06, when the civil service strike
and major wage settlement occurred)
*The precise measures to be taken under this action will be firmed up prior to the preparation of the second operation.
45
Policy Actions and Medium-Term Output/Outcome Indicators
Prior Actions – First Operation Triggers – Second Operation Output/Outcome Indicators
Promoting Structural Reform
4. The Recipient has approved guiding principles for
reforming the electricity tariff structure, aimed at a
financially sustainable and efficient electricity sector,
taking into account the planned shift to renewable
energy, with adequate protection for the poorest
consumers.
5. The Recipient has amended the petroleum pricing
templates in general accordance with the
recommendations of the independent reviews of said
templates, in order to ensure that consumer prices are
an accurate reflection of existing costs.
6. The Recipient has published the audited accounts of
the designated major public enterprises in order to
improve the transparency of the financial management
of said designated major public enterprises.
4. The Recipient will implement a new electricity tariff that, inter alia, provides for full cost recovery, establishes
financial incentives to generate and distribute electricity
efficiently, and institutes a lifeline tariff.
5. The Recipient will amend the regulatory framework for
the petroleum sector to, inter alia, define the regulated
assets of petroleum suppliers, institute systems to
independently value and inspect the regulated assets
of petroleum suppliers, and establish a system of
shared supplier shipping among petroleum suppliers.
6. The Recipient will bring the International Dateline Hotel
to the point of transaction, as recommended by an
internationally-reputable transaction adviser.
Electricity tariffs are set at a level that achieves full
cost recovery.
Baseline: 97.2 percent cost recovery
(mid-2011)
TPL despatches electricity from the lowest cost
sources of energy first.
Baseline: One source of energy (mid-2011)
The cost savings resulting from the implementation
of reforms to the petroleum supply chain are shared
with consumers.
Baseline: No benefit sharing (mid-2011)
The existing public enterprises portfolio is made
more focused on infrastructure services, as a result
of the progressive disposal of public enterprises
that undertake commercial activities, to reduce their
proportion to one third of the portfolio.
Baseline: 6 of the 14 public enterprises
undertake commercial activities (mid-2011)
Improving Social Protection
7. The Recipient has adopted a community public works
program targeted to poor and vulnerable communities.
7. The Recipient will complete the pilot of the community
public works program, and will take into account
lessons learned for scaling up the program.
In targeted communities there has been
incremental employment and income generation,
and community asset creation and/or rehabilitation.
Baseline: No beneficiary communities
46
ANNEX 3: FUND RELATIONS NOTE
47
48
49
50
ANNEX 4: SUPPORTING DOCUMENTATION FOR PRIOR ACTIONS
Supporting Documentation for Prior Actions
Prior Actions – First Operation Supporting Documentation
Strengthening Public Financial Management
1. The Recipient has instituted an in-year budget
reporting system that tracks key budget information
on a monthly and quarterly basis to strengthen budget
execution.
Ministry of Finance Circular instituting the in-year
budget reporting system in FY2011/12.
Budget reports for July 2011 and August 2011.
Confirmation from the Cabinet Secretary of the
submission of the reports to Cabinet for information.
2. The Recipient has reformed the budget calendar so
as to make budget proposals available to the public
when tabled in the Recipient’s Legislative Assembly,
in order to improve transparency in the process for
adopting the budget.
Cabinet decision to publish Cabinet's budget proposal
when submitted to Parliament from FY2012/13
onwards, and to endorse a revised budget calendar
for FY2012/13 to account for this decision by
providing Cabinet with more opportunity to deliberate
over the budget proposal during its preparation.
Strengthening Fiscal Policy
3. The Recipient has brought recruitment in all parts of
the public service under centralised control and has
applied a partial hiring freeze in the Recipient’s fiscal
year 2011-2012 to improve the management of the
public service wage bill.
Cabinet decision endorsing the policy actions to
control the management of the public service wage
bill in FY2011/12.
Ministry of Finance Circular providing guidance to line
ministries on the new rules and processes to be
followed with respect to the partial hiring freeze.
Promoting Structural Reform
4. The Recipient has approved guiding principles for
reforming the electricity tariff structure, aimed at a
financially sustainable and efficient electricity sector,
taking into account the planned shift to renewable
energy, with adequate protection for the poorest
consumers.
Cabinet decision to review the existing electricity tariff
to make it consistent with a financially sustainable and
efficient electricity sector, taking into account the
planned shift to renewable energy, while providing
protection for the poorest consumers, attaching the
draft Terms of Reference for the review.
5. The Recipient has amended the petroleum pricing
templates in general accordance with the
recommendations of the independent reviews of said
templates, in order to ensure that consumer prices are
an accurate reflection of existing costs.
Cabinet decision adopting an action plan to implement
the recommendations of the petroleum studies.
Independent reviews, Tonga Competent Authority
decision adopting the revised templates, and letter
from the TCA issuing the new template to companies.
6. The Recipient has published the audited accounts of
the designated major public enterprises in order to
improve the transparency of the financial
management of said designated major public
enterprises.
Newspaper notices of the publication of the audited
accounts of the six designated major public
enterprises.
Notices of the publication of the audited accounts on
the Ministry of Finance website.
Improving Social Protection
7. The Recipient has adopted a community public works
program targeted to poor and vulnerable
communities.
Cabinet decision to approve the community driven
development program, attaching the draft design of
the program.
51
ANNEX 5: GOVERNMENT OF TONGA: MEDIUM-TERM REFORM MATRIX
Government of Tonga: Medium-Term Reform Matrix
First Year Actions (Sep-11) Interim Steps (Mar-12) Second Year Actions (Sep-12) Progress to Date (Sep-11)
Strengthening Public Financial Management
Strengthening PFM building blocks
Identify and close redundant
government bank accounts to
improve cash management.
Revise the chart of accounts to
increase clarity and reduce redundant
and duplicate codes.
Continue to consolidate government
bank accounts to improve cash
management.
Consider what further revisions to
the chart of accounts may be
required to fully incorporate donor
expenditure.
Make further progress with the steps
leading to the establishment of a TSA.
Make progress with revising the chart
of accounts to fully incorporate donor
expenditure.
In moving towards a TSA, the
GoT has closed a significant
number of bank accounts, with
only a few accounts remaining.
This has been a great aid to cash
flow management, accounting and
reconciliations. The exception is
the large number of accounts still
required to fulfil conditions set by
donors, which the GoT looks
forward to cooperation to resolve.
The GoT revised the chart of
accounts prior to the beginning of
FY2011/12. This has improved
the accountability of expenditure,
through accurate and consistent
classifications, and improved the
credibility of the budget through a
more appropriate level of
disaggregation. Further rounds of
revisions are envisaged.
Strengthening budget execution
Institute an in-year budget
reporting system to strengthen
budget execution.
Remain on track with the in-year
budget reporting system (monthly
and quarterly budget reports for July
2011 – February 2012 have been
completed).
Make the quarterly budget reports
available to the public, to improve
the transparency of budget
execution.
Reports are being completed
within the month following the
month under review. They are
enabling Cabinet and CEOs to
be aware of the financial status
of individual ministries and the
government as a whole. Quality
and timeliness are the focuses.
52
Government of Tonga: Medium-Term Reform Matrix
First Year Actions (Sep-11) Interim Steps (Mar-12) Second Year Actions (Sep-12) Progress to Date (Sep-11)
Strengthening Public Financial Management
Increasing the credibility of the budget
Strengthen the links between line
ministries’ AMPs and annual budget
allocations.
Strictly reserve the use of the
Contingency Fund for the purpose set
out in the PFM Act.
Continue to strengthen the links
between line ministries’ AMPs and
annual budget allocations.
Continue to strictly reserve the use
of the Contingency Fund for the
purpose set out in the PFM Act.
Continue to strengthen the links
between line ministries’ AMPs and
annual budget allocations.
Continue to strictly reserve the use of
the Contingency Fund for the purpose
set out in the PFM Act.
For the FY2011/12 budget, the
Ministry of Finance tried to ensure
that budget allocations were
linked to the AMPs and CPs of
line ministries (in turn linked to
sector plans and the TSDF).
Improvements to the costing of
programs in line ministries’ AMPs
do need to be made, and Ministry
of Finance staff are working with
line ministries to achieve this, but
it remains a challenge.
Thus far in FY2011/12, those
requesting use of the CF have
been instructed to reprioritise their
activities or make savings in their
budgets, in order to avoid using
the CF for non-urgent, non-vital
and foreseeable expenditure.
Increasing the transparency of key budget processes
Reform the budget calendar to
make budget proposals available
to the public when tabled in
Parliament, to improve the
transparency of the budget
process.
Submit the annual financial
statements to the Auditor-General’s
Office on time (end of December
2012 for the annual financial
statements for FY2010/11).
Gazette the audited public accounts
on time (end of June 2012 for the
public accounts for FY2010/11).
Table the outstanding annual
reports from the Auditor-General in
Parliament, to improve the
transparency of the audit process.
From FY2012/13 onwards, the
public will have access to the
budget while it is being debated
in Parliament, and will be able
to compare Cabinet’s budget
proposal with the budget
approved by Parliament.
53
Government of Tonga: Medium-Term Reform Agenda
First Year Actions (Sep-11) Interim Steps (Mar-12) Second Year Actions (Sep-12) Progress to Date (Sep-11)
Strengthening Fiscal Policy
Improving revenue effort
Review tax policy and administration,
to identify opportunities to increase
revenue.
At Cabinet level, consider the
recommendations of the tax policy
and administration review and
decide on the implementation of the
reforms.
Implement reforms recommended
by the tax policy and
administration review, in order to
improve revenue collections over
the medium term.
The GoT has worked with PFTAC
on the revenue review, the report
of which is now in draft form. The
GoT is committed to implementing
measures to improve compliance
and reduce revenue loss through
exemptions and concessions.
Improving expenditure quality
Engage in a medium-term
expenditure mapping exercise to
better align expenditure with priorities.
Feed the findings of the expenditure
mapping exercise into the
FY2012/13 budget process.
Improve the alignment of government
expenditure with the GoT’s medium-
term policy objectives.
The GoT is working with the Bank
on the expenditure mapping
exercise. The GoT is focused on
improving the quality of
expenditure made from public
money, both in terms of
increasing allocations to priority
sectors and improving the quality
of spending within ministries. The
GoT is looking forward to building
the findings of the analytical work
into future budgets.
Strengthening management of the public service wage bill
Bring recruitment in all parts of the
civil service under centralised
control and impose a partial hiring
freeze, to improve the management
of the civil service wage bill in
FY2011/12.
Improve the frequency of payroll
reconciliations between PSC,
Treasury and the Budget Division.
Monitor and report on the operation
and fiscal impact of the performance
increment system in FY2011/12.
Make further progress with improving
the management of the wage bill,
including through continuing to
strengthen payroll and establishment
control, and appropriate
implementation of the proposed
government restructure.
The GoT’s measures ensure that
the partial hiring freeze applies to
all parts of GoT (whether under
PSC control or not), with the
exception of the social sectors,
and put the onus on requesting
ministries to properly justify any
exceptions sought to the freeze.
54
Government of Tonga: Medium - Term Reform Agenda
First Year Actions (Sep - 11) Interim Steps (Mar - 12) Second Year Actions (Sep - 12) Progress to Date (Sep - 11) Promoting Structural Reform Promoting energy sector reform E stablish a clear locus of
management for the energy sector within a single government agency, using existing powers.
A pprove guiding principles for reforming the electricity tariff structure, aimed at a financially sustainable and efficient electricity sector, taking into account the planned shift to renewable energy, with adequate protection for the poorest consumers .
A mend the petroleum pricing templates in general accordance with the recommendations of the independent reviews of said templates, in order to ensure that consumer prices are an accurate reflection of existing costs .
Monitor and report on the effectiveness of the n ewly established government agency that serves as a single point of responsibility for the energy sector.
At Cabinet level, consider the recommendations of the tariff review and decide on the implementation of the new electricity tariff.
Implement the next steps in the action plan to reform the petroleum sector – including undertaking a comprehensive review of the regulatory framework for petroleum.
Monitor and report on the effectiveness of the government agency that serves as a single point of responsibil ity for the energy sector.
I mplement a new electricity tariff that, inter alia, provides for full cost recovery, establishes financial incentives to generate and distribute electricity efficiently, and institutes a lifeline tariff.
A mend the regulatory fra mework for the petroleum sector to, inter alia, define the regulated assets of petroleum suppliers, institute systems to independently value and inspect the regulated assets of petroleum suppliers, and establish a system of shared supplier shipping among p etroleum suppliers .
The GoT has e stablished the T ERM - IU with an interim Director and with staff from relevant areas of GoT dealing with energy sector policy. The TERM - IU comes under the Ministry of Environment. The TERM - IU is suc cessfully working to coordinate donor activities in the energy sector, in line with the TERM. The TERM - IU is developing an operational business plan , to prop erly plan, prioritise and sequence its work.
The revision of the electricity tariff is moving ahead, with consumers expected to benefit from the new tariff early in the n ew y ear.
T he GoT is fully committed to implementing the findings of the petroleum studies conducted in 2010 by the Bank. Reducing Tonga ’s vulnerability to oil price volatility and oil price rise is critical. The TERM - IU is working very closely with the relevant authorities, including the Ministry of Commerce, to implement reforms to the petroleum sector to improve the managemen t of the petroleum supply chain .
55
Government of Tonga: Medium-Term Reform Agenda
First Year Actions (Sep-11) Interim Steps (Mar-12) Second Year Actions (Sep-12) Progress to Date (Sep-11)
Promoting Structural Reform
Advancing public enterprise reforms
Publish the audited accounts of the
designated major public
enterprises in order to improve the
transparency of the financial
management of said designated
major public enterprises.
Appoint an internationally-reputable
transaction adviser for a major public
enterprise.
Bring the International Dateline
Hotel to the point of transaction, as
recommended by an
internationally-reputable
transaction adviser.
This transparency measure is
part of a long trajectory of
reforms, designed to move
public enterprises onto a more
commercial footing. The GoT
worked hard to persuade public
enterprises to publish their
audited accounts. The impact
of the measure will come over
time, as civil society becomes
more interested in public
enterprise performance.
Promoting private sector development
Prepare a medium term reform plan
for the whole business licensing
system (general and ancillary
business licences) and the wider
business environment.
Implement the first steps in the
medium term reform plan for the
business licensing system and wider
business environment.
Implement the next steps in the
medium term reform plan for the
business licensing system and wider
business environment.
The Ministry of Commerce has
outlined a reform program for the
whole of the business licensing
system, addressing general and
ancillary licences, and licensing
and compliance issues. Donors
will now work with the Ministry to
help it prioritise, sequence and
implement this reform plan.
Improving Social Protection
Adopt a community public works
program targeted to poor and
vulnerable communities.
Prepare to pilot the community
public works program.
Complete the pilot of the
community public works program,
and take into account lessons
learned for scaling up the program.
With funding from the JSDF,
the GoT is now working to
implement this program, in
conjunction with NGOs.
Note: This is the GoT’s Medium-Term Reform Matrix, from which actions for the first operation and triggers for the second operation have been selected. Budget support from development partners is linked to the successful completion of the actions in bold typeface.
56
ANNEX 6: COUNTRY AT A GLANCE
57
N I U A S
VAVA ' U
H A ' A PA I
TONGATAPU
E U A
Neiafu
Pangai
Ohonua
NUKU'ALOFA
Niuafo'ou
Fonualei
Vava'u
Vava'uGroup
Ha'apaiGroup
KotuGroup
NomukaGroup
Late
KaoTofua
Ha'anoOfolanga
Foa
Uiha
Nomuka
HungaTongaHunga
Ha'apai
Fonuafo'ou
TongatapuEua
UolevaLifuka
Toku
TafahiNiuatoputapu
Otu ToluGroup
Albert MeyerReef
S O U T H
P A C I F I C
O C E A N
18°S
16°S
20°S
18°S
20°S
176°W 174°W
176°W 174°W
172°W
TONGA
This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.
0 25 50
0 25 50 Miles
75 Kilometers
IBRD 33498
NOVEM BER 2004
TONGADIVISION CAPITALS
NATIONAL CAPITAL
REEFS
DIVISION BOUNDARIES
INTERNATIONAL BOUNDARIES
