Report and Recommendation of the President to the Board of Directors

Project Number: 43152-01 November 2009

Proposed Asian Development Fund Grant Kingdom of Tonga: Economic Support Program

CURRENCY EQUIVALENTS (as of 10 November 2009)

Currency Unit – pa'anga (T$)

T$1.00 = $0.5337 $1.00 = T$1.8739

ABBREVIATIONS ADB – Asian Development Bank AusAID – Australian Agency for International Development CDD – community-driven development ERC – Expenditure Review Committee GDP – gross domestic product IMF – International Monetary Fund NRBT – National Reserve Bank of Tonga NSPF – National Strategic Planning Framework NZAID – New Zealand Agency for International Development PEFA – public expenditure framework assessment PMO – Prime Minister’s Office TA – technical assistance

NOTES

(i) The fiscal year (FY) of the Government and its agencies ends on 30 June. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2009 ends on 30 June 2009.

(ii) In this report, "$" refers to US dollars unless otherwise stated.

Vice-President C. L. Greenwood, Jr., Operations 2 Director General S. H. Rahman, Pacific Department (PARD) Sector Director Regional Director

E. Zhukov, Pacific Liaison and Coordination Office, PARD R. K. Leonard, South Pacific Subregional Office, PARD

Team leader E. Ferguson, Senior Country Specialist, PARD Team members L. Tora, Public Financial Management Officer, PARD

A. Woodruff, Young Professional (Economics), PARD S. Zaidansyah, Counsel, Office of the General Counsel

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

GRANT AND PROGRAM SUMMARY i

MAP

I. THE PROPOSAL 1 II. THE GLOBAL ECONOMIC CRISIS 1

A. Impacts on Tonga 1 B. The Government's Response 4

III. THE PROPOSED PROGRAM 13 A. Impact and Outcome 13 B. Policy Framework, Outputs, and Actions 13 C. Lessons 17 D. Important Features 17 E. Financing Plan 20 F. Implementation Arrangements 20

IV. PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS 23 A. Benefits 23 B. Risks and Mitigating Measures 24

V. ASSURANCES AND CONDITION 25 A. Assurances 25 B. Condition for Effectiveness 26

VI. RECOMMENDATION 26 APPENDIXES 1. Design and Monitoring Framework 27 2. Development Policy Letter and Policy Matrix 30 3. Economic Analysis 41 4. Fiscal Analysis 45 5. Public Enterprise Sector Assessment 52 6. Vulnerability Assessment 57 7. Status of the Response to the Global Economic Crisis 62 8. Development Coordination 67 9. List of Ineligible Items 71 10. Summary Poverty Reduction and Social Strategy 72

GRANT AND PROGRAM SUMMARY Recipient Kingdom of Tonga

Proposal An economic support program grant of $10 million to help Tonga

mitigate the impact of the global economic crisis; establish the basis for higher, more equitable and sustainable growth in the medium term; and create an economy more resilient to future shocks

Classification Targeting classification: General intervention Sector (subsectors): Multisector (public expenditure and fiscal

management, economic and public affairs management, social protection).

Themes (subthemes): Economic growth (promoting macroeconomic stability, promoting economic efficiency and enabling business environment); private sector development (policy reforms); governance (economic and financial governance)

Location impact: National (high impact)

Environmental Assessment

Category C. No significant adverse environmental impact is anticipated.

Social Safeguards Assessment

Involuntary resettlement: Category C Impact on indigenous people: Category C No involuntary resettlement or impact on indigenous people is expected.

Rationale and Description

Just as Tonga's economy began to recover from recent domestic shocks—the civil service strike in 2005 and civil disturbances in 2006—and the impact of global economic developments such as high oil and food prices in 2008, the prospects for economic growth have come under increasing pressure as a result of the global economic crisis. Recent recorded declines in remittances, a significant slump in trade tax receipts, weak export demand, declining tourism revenues, and weakening of credit flow within domestic banking, show that Tonga is now clearly feeling the impact of the crisis, somewhat sooner and to a greater extent than initially expected. The Government revised projected revenue for FY2010 down by 18.6%, to T$140.1 million from T$172.2 million. Government is forecasting a fiscal deficit of 10.3% of gross domestic product (GDP). As a result of this expected decline in revenue, as well as recent poor agriculture and tourism data, the Government revised its GDP growth forecast for FY2010 down to 0.4% (from 1.7%). To maintain fiscal responsibility in the short term, while ensuring social sector expenditure is protected, the Government will need to reduce planned expenditure, and continue critical reforms to address underlying structural constraints. If these constraints are not removed, sound fiscal management and increased economic resilience will not be achievable. Possible Government responses comprise fiscal, structural, and social policy measures, supported by prudent monetary policy.

ii

The Government will need budget support to (i) protect essential social expenditure for segments of society most adversely affected by the crisis, and (ii) advance structural reforms to improve medium-term competitiveness and productivity.

Impact and Outcome The impact will be higher and more inclusive economic growth. The main outcome will be a timely and effective response to the crisis.

Special Features The program provides a quick-disbursing response to the impact of the crisis. This is a priority need as Government expected a longer lag before the impacts of the crisis were felt; however, the impacts are now being observed and as a result the planned FY2010 budget is under significant pressure. The program also supports implementation of an extensive public and private sector reform agenda that is geared to improving productivity, and medium-term growth prospects. ADB has been engaged in these program areas over the past 5 years and has underpinned Government actions with significant analytical work and ongoing technical engagement, especially in the areas of public financial sector management, structural reform, and infrastructure. The program supports implementation of the Asian Development Bank (ADB) country partnership strategy for Tonga, and links into partnerships with other development agencies.

Financing Plan ADB will provide a grant of $10,000,000 from ADB's Special Funds resources. Factors that have been taken into account in determining the grant size include the projected magnitude of the economic, fiscal, and social impact of the global economic crisis on Tonga; the scope and fiscal implications of an effective policy response to the crisis; and the Government's continued commitment to a significant economic and public sector reform agenda. The Government will ensure that the local currency funds generated by the grant will be used to continue support towards implementation of structural and public financial management reform measures, and protection of core social expenditure.

Tranching The grant will be released in two tranches. The first tranche ($5 million) will be released upon grant effectiveness, the condition for effectiveness being that all first tranche conditions will have been met to the satisfaction of ADB. The second tranche ($5 million) will be released as soon as ADB is satisfied with progress in implementing the program, in particular, that all the second tranche conditions are met. The indicative timing for release of the second tranche is November 2010.

Period of Utilization The grant proceeds are expected to be fully used by December 2010.

Estimated Program Completion Date

Program completion is estimated in June 2011.

iii

Executing and Implementing Agencies

The Prime Minister's Office is the executing agency. The Ministry of Finance and National Planning; the Ministry of Public Enterprises; the Ministry of Labor, Commerce and Industry; and the Ministry of Health, will be the implementing agencies.

Procurement and Disbursement

Grant proceeds will be used to pay for items procured in ADB member countries, other than the items specified in the list of ineligible items and imports financed by other bilateral and multilateral sources. The proceeds of the program grant will be disbursed in accordance with provisions of ADB’s simplification of disbursement procedures and related requirements for program loans and grants. Grant proceeds disbursed against imports will require a certificate from the Government stipulating that the volume of eligible imports exceeds the amount of ADB's projected disbursements under the grant for the given period. ADB reserves the right to audit the use of grant proceeds to verify the accuracy of the Government’s certification.

Program Benefits and Beneficiaries

In light of the crisis, the program provides the Government with additional financial resources to support the protection of the most vulnerable members of society from the impacts of the crisis, and to continue with structural reforms which will promote economic growth and the maintenance of stability.

Risks and Assumptions

The program is built around the Government's commitment to address the crisis by exerting budgetary prudence, while maintaining core social expenditure, and continuing with its extensive structural reform program. The main risks are capacity related and political. The program relies on the private sector responding positively to structural reforms and improved global economic conditions; and government agencies committing to improving performance and having the capacity to implement the substantial reform agenda. Since early 2009, private sector response to the Nuku'alofa reconstruction measures following the 2006 civil disturbance has increased considerably. Government agencies have demonstrated sufficient absorptive capacity especially for structural reform, as demonstrated by recent progress. The program continues the process of reform which ADB engagement has facilitated over the past 5 years. The program is harmonized with the relevant activities of development partners. The ongoing reform process and the support generated within the civil service and the private sector is partly addressing the risk of shifts in political attitudes and commitment given the general elections scheduled for late 2010. Political commitment to structural reform is high in Tonga; the program components will be implemented by the time of the general elections. A postprogram monitoring framework will be instrumental in maintaining the program’s momentum and sustainability over the medium term.

Inte

rna

tion

al D

ate

line

S o u t h P a c i f i c O c e a n

N o r t h P a c i f i c O c e a n

C o r a l S e a

S O U T H P A C I F I C O C E A N

PhilippineSea

V A V A ' U G R O U P

H A 'A P A I G R O U P

T O N G A T A P U G R O U P

TONGATAPU

15 35'So

175 40'Wo

Neiafu

Pangai

NUKU'ALOFA

Ha'atafu

Ha'akili

Ha'avakatolo

Te'ekiuNukunuku

Ha'utu

Houma

Utulau

Pea

Vaini

Mu'a

Talafo'ou

NavutokaNUKU'ALOFA Kolonga

Niutoua

Fatumu

Ha'asini and Hamula

Fua'amotu

PACIFIC REGION

NAURU

SOLOMONISLANDS

FEDERATED STATES OFMICRONESIA

K I R I B A T IPAPUA

NEW GUINEA

MARSHALL ISLANDS

VANUATU

A U S T R A L I A

REPUBLICOF THE

FIJIISLANDS

TUVALU

TONGA

SAMOA

COOKISLANDS

REPUBLICOF PALAU

'Atata

Fukave

Eueiki

Ata

Polo'a

Fonualei

Toku

Kapa

Hunga

Nuapapu

Ofolanga

Mo'unga'one Ha'ano

Foa

Kao

Tofua

Uiha and Felemea

Uoleva

Uonukuhahake

Kotu

MatukuO'ua

Nomuka Fonoifua

Telekivava'u

Telekitonga

Lalona

Kelefesia

Kalau

'Ata

Tonumea

Falcon

Hunga Tonga

Hunga Ha'apai

Mango

TONGATAPU

'Atata

'Euaiki

'EUA

Tafahi

VAVA'U

NIUATOPUTAPU

NIUAFO'OU

LIFUKA

Motutapu

Fafa Onevai

National Capital

Town

Airport

Road

International Boundary

Boundaries are not necessarily authoritative.

TONGA

ECONOMIC SUPPORTPROGRAM

0 5 10 15

Kilometers

20 25

N

09-4287 HR

176 13'Wo

22 21'So

0o0o

170 00'Wo

170 00'Wo

150 00'Eo

150 00'Eo

20 00'So20 00'So

20 00'No20 00'No

174 00'Wo

174 00'Wo

175 30'Wo

175 30'Wo

21 00'So21 00'So

19 00'So 19 00'So

174 00'Wo

174 00'Wo

16 00'So16 00'So

175 10'Wo

175 10'Wo

21 00'So21 00'So

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on a proposed grant to the Kingdom of Tonga for the Economic Support Program. The design and monitoring framework is in Appendix 1. The development policy letter and policy matrix is in Appendix 2.

II. THE GLOBAL ECONOMIC CRISIS

A. Impacts on Tonga

2. Tonga, like other small, remittance-dependent economies in the Pacific region is highly vulnerable to domestic and external shocks. Over the past decade, real gross domestic product (GDP) growth averaged 1.8% per annum—well below the regional average of 3.2%. Underlying structural constraints, political disturbances, and global economic developments restricted the pace and depth of growth. While agriculture and fishing remain the largest contributors to overall output—accounting for 20% of total output—their importance is diminishing relative to the sharp growth in services led by communications and tourism, coupled with recent poor export prices and fishing conditions (Appendix 3). 3. Tonga’s private sector is relatively small and its development nascent. The public sector is large and public enterprises have traditionally occupied sizable portions of productive sectors of the economy, controlling around 20% of fixed assets yet contributing only 6% to GDP.1 Private sector growth has been further constrained by excessive regulation and discretionary licensing requirements. Efforts to diversify Tonga's economic base, and to implement structural reforms to increase overall productivity and improve the economy's resilience, remain critical. 4. In FY2008, Tonga's economy grew by 2.7%—the highest growth rate registered since FY2002—driven by expansion in construction, transport and communications, and finance and real estate. However, sharp increases in the price of fuel in the second half of 2008, as well as the decline in recorded remittances as global conditions weakened, placed renewed pressure on the economy and highlighted structural weaknesses that need to be more completely addressed. 5. The global economic crisis has adversely affected Tonga's economy, and GDP contracted by 0.5% in FY2009. This contraction has put added pressure on the fiscal position. Just 2 months into FY2010 (end of August 2009), the budget outturn showed a fiscal deficit of T$7.5 million (1.0% of GDP) based on a significant decline in government revenue, particularly trade taxes (which closely track remittance trends) which declined by 18.9%— a budget shortfall of T$19.0 million—over the first two months of FY2010. This contraction resulted in a severe cash shortage, and will impact government expenditure programs unless the Government takes steps to reprioritize spending (paras. 18–24 and Appendix 4). Only a weak recovery of 0.4% is forecast for FY2010, premised on growth in nonexport agriculture, and the flow-through effects of government expenditure.2

1 ADB. 2009. Finding Balance: Making State-Owned Enterprises Work in Fiji Islands, Samoa, and Tonga. Manila. 2 The revised government growth and revenue estimates for FY2010 were released in Ministry of Finance and

National Planning. 2009. At A Glance. September. Nuku'alofa.

2

Figure 1: Revised Monthly Revenue Forecast FY2010

0

2

4

6

8

10

12

14

16

18

20

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

T$ m

illio

n

Monthly Average FY2006-09 Actual Collections Forecast FY2010

6. The impact of the global economic crisis is reflected in the following:

(i) Revenue. Government revenue has shown a declining trend over the past 18 months as private expenditure and incomes have fallen. Tax revenue (primarily income tax and consumption tax) comprises around 80% of total revenue. While trade taxes (25% of total revenue) have declined by 5.6% year-on-year, the rate of decline has increased in FY2010 with total revenue falling 18.9% in the first two months of the fiscal year (Figure 1). Actual collections at the end of August 2009 necessitated a revised revenue forecast for FY2010. Revenue projections for FY2010 were revised down 18.6% to $T140.1 million, from the FY2010 budget estimate of T$172.2 million.

(ii) Remittances. Remittances, which traditionally account for 31% of GDP, have fallen sharply. In the 12 months to July 2009, remittances fell by 17% to around 22% of GDP. The flow of remittances—both cash and in-kind—provides an important source of household income and social protection for many Tongans.3

(iii) Exports. Decline in commodity prices as well as, more recently, weak global demand have quickly lowered incomes for smallholders and plantations. Agriculture, fishing and forestry account for around 62% of exports by value. Moreover, Tonga's export base has shrunk as smallholders have shifted to root crops for domestic consumption and subsistence farming. On a year-on-year basis, nonexport agriculture increased by 80% in FY2009 while export agriculture—primarily squash, vanilla, and fish—fell by 35%.

3 A World Bank survey found that in 2004, more than 90% of households in the country received remittances. On

average, the annual remittance flow amounted to $3,067 per household (or $745 per person).

Source: Ministry of Finance and National Planning.

3

(iv) Household incomes. Overall household spending has declined as rural incomes have weakened, and as the flow of remittances declined. Import demand declined by around 35% in the year to July 2009.

(v) Tourism. Tourism, which accounts for about 10% of GDP, has weakened. Tourist arrivals at the end of July 2009 declined by 2% on a year-on-year basis, while tourist receipts fell by 13.5% over the same period.

(vi) Business activity. The slowdown in the economy and weakened demand for tourism appears to be impacting retailers in urban areas, several reported declines of 30%–40% in sales in the first quarter of 2009. In line with weakened domestic demand, the commerce subsector (largely retail and wholesale traders) declined by 6% in FY2009. The results of the Tonga Chamber of Commerce and Industry survey, conducted in the first half of 2009, indicates that more than 70% of businesses believe that the overall business environment in Tonga deteriorated over the previous 12 months.4 Inventories have risen, nonpayment of trade credit has become an issue, and access to finance has deteriorated given the more rigorous lending criteria adopted by the banking system. More than half of the businesses surveyed attributed the subdued commercial environment to the crisis.

7. While recent data on poverty and hardship is not currently available (a new household income and expenditure survey is under way5), subdued economic conditions, combined with the significant decline in remittances, will likely translate into higher unemployment and increased hardship for the poor and vulnerable. The lack of formal social protection systems is likely to compound impacts on the poor and vulnerable, although subsistence farming offers some relief. Tonga does have the advantage of free health and education services to help reduce social impacts, which otherwise might have arisen due to reduced access. 8. Weak revenue performance will place significant pressure on government expenditure programs. This in turn has the potential to add to pressure on the most vulnerable members of the community from an easing in labor demand and the high cost of living. Women are particularly exposed as they are often overrepresented in lower-paid jobs in most sectors of the economy, in particular handicraft production, which form the basis for a significant part of remittance flows. An in-depth analysis of the social impacts of the crisis is needed to design, pilot, and implement appropriate social protection measures.6 9. Following the civil unrest in November of 2006, the Government made a significant effort toward securing financing for the reconstruction of the capital city, Nuku’alofa. This includes donor grants of about T$15 million, which were channeled through designated banks to business entities affected by the riots in the form of off-budget, low interest rate loans in the second half of FY2008. The Government also signed a long-term T$120 million reconstruction loan from the Export–Import Bank of China (China Eximbank) in November 2007. 7 Disbursements of this loan were initially postponed, as the Government sought to ensure it was used productively, and while it negotiated for use of local inputs. The first drawdown of T$40 million was made in April 2009. It is the Government's intent to use loan proceeds in broadly 4 Tonga Chamber of Commerce and Industry. http://www.tongachamber.org 5 The last household income and expenditure survey for Tonga was undertaken in 2001. Preliminary analysis of the

new survey should be available by the end of 2009. 6 ADB is considering such an initiative on a regional basis for selected Pacific developing member countries

(including Tonga) affected by the global economic crisis. 7 The loan, which bears a 2% interest rate, will be repaid over 20 years with a 5-year grace period.

4

equal measure to finance public works in the capital and to onlend to the private sector for office and retail construction. 10. According to the recent International Monetary Fund (IMF) Article IV mission, Tonga remains at high risk of debt distress. Nonetheless, the projected debt profile is consistent with manageable—if high risk—debt dynamics. Under the baseline scenario, the ratios of net present value of debt to GDP as well as the net present value of debt to export remain above the country-specific indicative thresholds for a prolonged period.8 Tonga’s total public sector debt stock (including publicly guaranteed debt) declined to 34% of GDP in FY2008 from 40% of GDP in FY2006. External debt to GDP also fell by about 11.3%, while fiscal consolidation contributed to a downward trend in domestic public debt to GDP. At the same time, Tonga benefits from very high remittance inflows, which are by far the largest source of foreign exchange earnings and help mitigate liquidity risks. Tonga’s overall public sector debt indicators, while elevated over the short term, show a decreasing trend over the longer run. 11. The IMF staff report warns that any drawdowns on loans will lead to high-risk debt over the medium term, and any additional external borrowing should be strictly limited. Reflecting this, during the IMF board's consideration of the Article IV report, Tonga's representative stated that "authorities have been able to secure an additional concessional loan amount of $45 million for infrastructure development recently. However, it is realized that the disbursement schedule needs to be modified to avoid the increase in risk of debt distress."9 12. The IMF concludes that taking into account the cushion provided to the economy by the high workers’ remittances, the projected debt profile is consistent with manageable—if high risk—debt dynamics. The results of the debt sustainability analysis underscore the importance of maintaining broadly balanced budgets following the completion of reconstruction borrowing and sustaining growth near or above historical averages. Both are key to maintaining stable debt in the medium term and declining debt in the long term. Additionally, prudent debt management policies, including keeping within sustainability parameters, must be adopted to minimize exposure to risk (and the potential for debt distress). B. The Government's Response

1. Monetary Policy

13. Prior to June 2009, the National Reserve Bank of Tonga (NRBT) adopted a tight monetary policy stance to ensure achievement of its principal objectives to maintain internal and external monetary stability, and promote a sound and efficient financial system. This stance achieved its desired effects as foreign reserves continued to increase and inflation declined. 14. Credit to the private sector declined in FY2009 by 2.9% as commercial banks substantially tightened lending criteria in response to substantial bad debts (incurred prior to the

8 This scenario assumes that the real GDP growth rate will revert close to its historical average following a slowdown

in FY2009 and FY2010. The reconstruction loan will be drawn down over 4 years. Excluding reconstruction spending, public spending will be broadly limited to projected revenues and grants over the medium term, and will, thus, minimize additional external borrowing. Although exports are expected to remain constrained, remittances, which are the largest source of foreign exchange earnings, are expected to remain an important external cushion over the medium term.

9 IMF. 2009. Statement by Duangmanee Vongpradhip, Executive Director for Tonga and Dicky Kartikoyono, Senior Advisor to Executive Director, Executive Board Meeting 09/92, 4 September.

5

crisis).10 As economic conditions rapidly worsened, NRBT moved to ease credit conditions. However, effectiveness of monetary policy in responding to the crisis is limited due to weak transmission mechanisms and the pegged exchange rate. 11 Nonetheless, NRBT reduced reserve requirements for commercial banks from 10% to 5% and has, more recently, taken the initiative to bring down lending rates by requesting banks’ to review their lending margins.12 However, overall credit growth continues to be constrained.

15. Further monetary policy easing remains an option, as foreign reserves were at 5.4 months of import cover as of July 2009, in part due to reduced imports. Inflation continues to abate.

2. Fiscal Measures

16. The Government’s fiscal policies are aligned with the outcomes and objectives set out in the new National Strategic Planning Framework. 13 The Government has committed to the following fiscal parameters over the medium term:14

(i) operate responsible and prudent fiscal and monetary policies; (ii) base revenue policy on providing equal opportunities for all; (iii) ensure that the national debt remains sustainable, as appropriate; (iv) move to more efficient and effective government and the transfer of resources to

improve services and maintain assets; (v) continue its public enterprise rationalization process; (vi) ensure revenue collection methods are effective and nondistortionary; and (vii) apply a coordinated whole-of-government approach to development partner

funding. 17. The Government, in setting its FY2010 budget, recognized that the economy would be vulnerable to the global downturn for some time and that this requires implementation of prudent and appropriate economic policies to maintain macroeconomic stability. An expansionary fiscal stance was adopted to counter expected impacts of the crisis (Table 1).

10 Due to an overexpansion in lending during FY2008 by the major commercial banks, the banking system is now

going through a consolidation phase. Both the Australia and New Zealand Banking Group (ANZ) and Westpac have made provisions for bad debts amounting to around 20% of their portfolios. By June 2009, both banks had recovered approximately half of the provisions; both have significantly tightened their lending criteria.

11 Tonga pegs its exchange rate to a trade-weighted basket of currencies (including the United States, Australian, and New Zealand dollars). The exchange rate appreciated 6.0% in real effective terms in 2008.

12 Commercial banks were responsive to NRBT's request to reduce interest rates further. The weighted average lending rate fell by 1.2% in July 2009 (month-on-month basis), and business rates decreased by 2.8%. Housing rates, however, increased by 2.2%—reflecting tightened lending conditions in response to the increasing number of nonperforming loans.

13 The government has in principle approved, and is now finalizing, a new national strategic planning framework, which will assist its efforts in effectively addressing the crisis. In particular, the new framework aims to ensure sustained equitable economic growth in Tonga by focusing, among other areas, on private sector growth, infrastructure development and maintenance, community development, and health and education. Smaller and more efficient government, better public enterprise governance and performance, and improved effectiveness of revenue collection and programs are among the enabling themes for the public sector.

14 Government of Tonga. 2009. Budget Statement for Year Ending 30th June 2010. Budget Paper 2: Fiscal Outlook. Nuku’alofa.

6

Table 1: Summary of Budget Outcomes and Official Estimates for FY2010 (T$ million)

Item FY2007 FY2008 FY2009 Actual

FY2010 Budget

FY2010 Reviseda

Total revenue and grants 170.6 172.2 199.9 210.1 178.0 Revenue 148.3 163.5 154.5 172.2 b 140.1 b Grants 22.3 8.7 45.3 37.9 c 37.9 c Total expenditure and net lending 164.1 161.5 188.0 202.7 202.7 Wages and salaries 85.5 80.0 81.0 87.7 87.7 of which employer contribution 5.8 9.8 5.2 10.3d 10.3d Other current expenditure 73.6 78.4 83.4 103.9 103.9 Capital expenditure 5.6 3.0 17.4 11.8 11.8

Net lending (0.6) (0.1) 6.3 (0.6) (0.6) Overall balance 6.5 10.8 11.8 7.4 (24.7) Debt repayment 6.7 10.8 1.4 17.4 17.4

Net Financing Requiremente (0.3) 0.0 (10.3) (10.0) (42.1) ( ) = negative. a The Government of Tonga revised its FY2010 revenue and gross domestic product forecasts in light of data from

the first 2 months of FY2010. b This estimate excludes the rollover of a T$7 million bond. c The budget estimates assume a T$10 million equivalent grant from ADB, which is excluded from this statistic to

accurately reflect the underlying deficit and financing gap. Otherwise the summary numbers exactly reflect the budget estimates.

d Pension payments by the government for employees to the Government Retirement Fund Board. This amount contains a provision (T$3 million) for a payment to the transfer value of the scheme, as estimated upon its inception, which was carried over from the FY2009 budget, having not been expended.

e The net financing requirement is derived after accounting for the budget balance plus total debt repayments. Source: Government of Tonga FY2010 Budget Statement; Ministry of Finance data. 18. Projected expenditure in the FY2010 budget is 13.7% higher than the FY2009 provisional outturn, which in turn was up 10.3% on FY2008. Expenditure is projected to increase across all key components: wages and salaries (8.3%); capital expenditure, inclusive of off-budget loan-funded reconstruction efforts (241%); and current expenditure (20.3%). The Government also budgeted T$17.4 million for increased debt prepayments, although this amount is expected to be significantly less. The Government commits that program funds will not be directed to debt repayment given the expectation that the overall budget balance will be greater than the value of the economic recovery support program grant. Table 1 provides an overview of the budget outcomes and official estimates for FY2010, including the financing gap. Taking into account the expectation of lower revenue and without any compensatory expenditure reductions, the financing gap is T$42.1 million. 19. Budgeted capital expenditure does not present the government's full investment plans. The government's own capital expenditure allocation in FY2010 has fallen to T$11.8 million from an estimated outturn of T$17.4 million in FY2009, however this apparent decline reflects one-time property purchases that inflated capital spending in FY2009 by approximately T$9.7 million.15 The capital spending priorities in the FY2010 budget include office building renovations (T$4.1 million), road maintenance (T$6.7 million), purchase of new plant (T$4.3 million), and new equipment (T$2.1 million)—some of these are reflected as current expenditure in the budget. The reconstruction loan from China Eximbank funds a substantial portion of the rebuilding of Nuku'alofa and associated works. However, the ‘in-kind’ portion of the loan amount is not included as a cash appropriation and hence, the total loan amount is not reflected in the cash capital expenditure estimate in the government finance statistics presentation in the

15 The government purchased property overseas for diplomatic use.

7

Budget Statement FY2010 (although a full government finance statistics presentation would capture both cash and in-kind components)16 T$40 million of these loan funds were drawn down in April 2009.17 Inclusive of this T$40 million, total capital expenditure amounts to T$51.8 million in FY2010 compared with T$17.4 million in FY200918—an increase of 241%. While the full loan amount will not be expended, a large increase in capital spending is expected. Coupled with effective enforcement of high local content in the implementation of capital works, the government's capital spending may facilitate employment creation and business activity in some sectors. 20. Other current expenditure increased by 24.6% from FY2009. This is partly attributable to a significant increase in purchases of goods and services by T$16.2 million (26.3%) reflecting expenditure in support of a European Union-funded agriculture project, road maintenance, and other capital investment related items (para. 19). Increases in subsidies and other current transfers (by 24.2%) is a further contributory factor. The key element of this increased expenditure comprises the transfers to nonprofit organizations, largely supporting increased costs of community service obligations, such as shipping, power, and airline services (up 86% in FY2009), and scholarships (up 16%). Subsidies to public enterprises (T$2 million) will support the cost of upgrading street lighting and operating the waste management authority. The Government expects that significant expenditure savings can be achieved from current expenditure. 21. The Government recognizes the need to contain operating expenditure if it is to maintain the provision of basic social services and manage the deficit. During the preparation of the FY2010 budget, efforts were made by the Expenditure Review Committee (ERC)19 to subject expenditure proposals from the ministries to closer scrutiny, and to decrease expenditure on lower-priority initiatives. FY2009 expenditure allocations identified as low-priority operating expenditure and subsequently reduced in the FY2010 budget include

(i) overseas travel (T$2.07 million cut in budget); (ii) office supplies, printing and stationary, and subscriptions (T$1.16 million cut in

budget); (iii) hospitality (T$482,000 cut in budget); and (iv) rental (T$267,000 cut in budget).

22. Underlying revenue declined by 5.5% in FY2009; the Government forecast it to increase by 11.5% in FY2010 given improved compliance and positive government growth forecasts. However, actual revenue during the third quarter of 2009 was about 21% below the monthly average for collections (Figure 1). The revised government estimate suggests a 26% contraction in revenue in FY2010.20 This is being driven by a significant reduction in trade taxes 16 In 2007, the government signed a CNY440 million ($61 million) loan agreement with China Eximbank for the

reconstruction of buildings destroyed by fire in 2006. Approximately 50% of the loan will be used to upgrade streets, water, and sewage, plus the reconstruction of Vuna wharf. The remaining 50% will be onlent to the private sector for the reconstruction of buildings destroyed by the fire, with the government guaranteeing the exchange risk. Australia and New Zealand have provided additional reconstruction funds as grants (T$15 million); these are being onlent to the private sector.

17 While the overall allocation of the loan is equally split between government and private sector use, the intended allocation of this drawdown is not available.

18 The China Eximbank loan contributed T$5.0 million to capital expenditure in FY2009. This does not appear in cash expenditure, but is part of the net lending component of the FY2009 outcome.

19 The ERC is chaired by the Prime Minister and comprises the deputy prime minister; the minister of finance and national planning; chairperson of the public service commission. The ERC regularly meets at least on a monthly basis, and as required.

20 The IMF 2009 Article IV staff report projected a revenue shortfall of T$20 million.

8

(forecast to be 73% below budget), reflecting both reduced imports and collection difficulties. Grants are also forecast to decline from the T$45.3 million21 budget outcome in FY2009 to T$37.9 million in FY2010 (exclusive of the ADB grant). Given the need to revise the revenue forecast, unless further expenditure restraint is exercised, the resulting underlying fiscal deficit is expected to reach T$42.1 million (10.3% of GDP). 23. The Government has a number of options to respond to the budget gap created by the lower than expected revenue, and expects to utilize a mix of these options. Some reduction in, and reprioritization of, expenditure has been an initial response. The Government, in addition to advising heads of departments of the current fiscal position and the need for prudent management of expenditure, identified T$18 million in potential budget savings in response to the worsening fiscal situation. Potential savings include (i) T$4.2 million in deferred debt repayments, (ii) T$4 million budgeted for the Government's contingency fund, (iii) T$2 million from purchases of goods and services (across all ministries), and (iv) T$500,000 from travel and communication (across all ministries). Moreover, the Government has given assurances that priority areas such as core social expenditure will be protected, capital expenditure maintained to the extent possible, and payments to the private sector continued.22 Implementation of the expenditure adjustments will in the first instance reduce the financing gap to T$24.8 million. The program grant would reduce the gap to T$14.8 million. The Government is currently exploring other options to finance the balance, including seeking additional development partner support, or through the sale of bonds. The sale of bonds is expected to be largely taken up by the commercial banks, and will not reduce the availability of credit to the private sector given ongoing consolidation in the banking system, and the resulting decline in private sector credit growth. 24. Pressures on the budget. In 2005, the Government entered into a public sector wage agreement in which it committed to implement salary increases for the public sector of between 60% and 80% by FY2006, and to undertake regular salary reviews. Following this, the Government implemented a large program of voluntary redundancies, which resulted in an 18% reduction in the number of government employees. Nonetheless the wages and salaries bill (including redundancy costs) increased to 52% of budget in FY2007 before falling back to 43% in FY2009. A 10% salary increase for civil servants is budgeted for FY2010 (3 years after the last salary increase). This is balanced by (i) reducing leave provisions to bring these in line with the private sector and regional public service comparators compensation for reduced allowances for vacation, sick, and casual leave (conversely, maternity leave was increased from 1 month to 3 months); (ii) strengthening performance evaluation to increase the professionalism of the public service; and (iii) eliminating job vacancies, traditionally funded in the budget, and reducing the number of employees. The overall impact is a projected 8.3% increase in expenditure for wages in FY2010. The timing of this increase has proved unfortunate. A growing wages bill, if positions are increased or as further demands for wage increases arise, is a potential source of expenditure pressure on the budget.23 21 This is the FY2009 actual amount, which reflects an extraordinary grant from the People's Republic of China of

T$25 million, which was not included in the FY2009 budget. 22 The Ministry of Finance established a cash flow management framework that ensures that cash inflows and

outflows are matched, as well as a minimum cash flow reserve (1 month expenditure). Earlier in FY2010, a tight cash flow situation, resulting from lower than forecast revenue collected, meant that payments to suppliers were being made within a 14-day period rather than upon receipt of invoices. However, the situation has since improved and payments are being made earlier. In addition, government ministries have been advised to only place orders for supplies, and other commodities, when cash is available.

23 The salaries and wage expenditure in the budget consists of several items that are not strictly part of the public sector wage bill, such as allowances for legislators, the privy purse, and district and town officers salaries. The salary component of the salary and wages line items in the budget estimates constitutes approximately 77% of the

9

25. Public enterprises have been a significant area of government reform (Appendix 5). Typically these create substantial demands on the budgets of Pacific governments in the form of subsidies and credit guarantees. Tonga is notable in that its public enterprise reform program has resulted in clear identification of community service obligation costs and a significant reduction in subsidies; in FY2010, these are expected to amount to just T$2 million.

3. Complementary Structural and Governance Reforms

26. In recent years, the Government has been implementing important structural reform measures to improve productivity and create a greater role for the private sector in the economy, and thus boost the medium-term economic growth rate. The reforms focus on strengthened public financial management, public sector reform (through improved public sector productivity and public enterprise rationalization), and an improved operating environment for the private sector. ADB has supported Tonga in this reform process with national and regional technical assistance (TA). 24 The continuation of these reforms place Tonga in a stronger position to mitigate the impacts of the crisis and will help the economy reemerge more quickly and stronger. 27. The 2007 assessment of public financial management used the public expenditure and financial accountability (PEFA) framework. 25 It identified that the existing public financial management systems and processes need improvement in terms of effectively formulating, implementing, and monitoring government budgets. Inadequate expenditure management has two consequences: (i) control of the budget rests on short-term cash availability, rather than systematic cash-flow forecasts, so that budgeted spending often does not occur when it is needed; and (ii) inadequate budget controls prevent accurate spending on budget priorities, particularly capital and social expenditure. A further consequence is that poor budgetary controls increase the difficulty of monitoring critical revenues and expenditures during the crisis so that the economy could be thrown off course if unexpected developments occur, either internally or externally. 28. While overall fiscal discipline is generally well maintained, issues in the processes of developing and implementing budgetary policy, expenditure tracking, and the analytical classifications on which to base fiscal policy are areas of concern.26 In particular, (i) many issues have been identified around the methodology and standards used to prepare budgets,

total, including employer contributions. Excluding these and the employer contributions, which is mandated in the administrative regulations to the 1998 Retirement Fund Act, the total wages and salaries component of the FY2010 budget will rise 2.2%.

24 ADB. 2002. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the Kingdom of Tonga for the Economic and Public Sector Reform Program. Manila (Loan 1904-TON[SF], $10 million, approved on 28 May); ADB. 2003. Technical Assistance to the Kingdom of Tonga for the Rationalization of Public Enterprises. Manila (TA 4111-TON, $515,000, approved on 9 May); ADB. 2004. Technical Assistance to the Kingdom of Tonga for Public Enterprise Reform, Phase II. Manila (TA 4514-TON, $150,000, approved on 20 December); ADB. 2006. Technical Assistance to the Kingdom of Tonga for Rationalization of Public Enterprises, Phase III. Manila (TA 4899-TON, $400,000, approved on 18 December); ADB. 2009. Reforming Public Enterprises. Manila (TA 7271-TON, $500,000, approved on 14 April).

25 Government of Tonga. 2007. Public Financial Management Performance Report. Nuku’alofa. 26 Government of Tonga. 2009. Public Financial Management Support Program. Nuku'alofa. Prepared with support

from ADB. 2006. Technical Assistance to the Kingdom of Tonga for Support for the Implementation of the Strategic Development Plan 2006/07–2008/09. Manila (TA 4865-TON).

10

and the control of budget implementation; and (ii) despite some progress, problems with accounting, recording, and reporting continue.27 29. The Government is committed to addressing these issues, and a number of important reform measures are under way or planned in the areas of budgetary management, public sector procurement practices, internal expenditure controls to reflect the Public Financial Management Act, efficiency of the public financial management system, and policy development and implementation. In particular, over the past 2 years, some of the public financial management improvements include (i) existence of and adherence to a fixed budget calendar through the role played by the ERC in coordinating, allocating, and ensuring compliance with the budget strategy; (ii) preparation of the FY2010 budget using forward estimates as a first step to a medium-term budget framework; (iii) up-to-date public accounts (FY2008 accounts were signed by the auditor general and FY2009 accounts will be submitted to for auditing by December 2009; (iv) monthly bank reconciliations; (v) regular cash flow management reports and advice to management, with the daily cash position being reviewed within line ministries; (vi) government financial managers meet on a quarterly basis, (vii) procurement regulation is in its final stage for submission to the cabinet's law committee before the end of 2009; (viii) strengthened assets register; (ix) regular reporting on public debt status; and (x) improved recording of development partner assisted projects. 30. ADB’s 2008 private sector assessment for Tonga (Appendix 5) identifies several structural issues as reform priorities for private sector development, including (i) an oversized and unproductive public sector (both public enterprises and the public service), which lowers overall productivity in the economy; (ii) an outdated and ineffective commercial legal framework, which makes establishing, operating, and exiting business difficult and costly; (iii) weaknesses in the licensing and regulation of businesses, which raises transactions costs; and (iv) difficulties in accessing finance.28 Commercial law reform to strengthen the business environment is well advanced and requires completion. Work to improve access to finance through a reformed collateral framework and enhance financial services is progressing but needs continued attention. 31. The ongoing public enterprise reform program, which is one of the pillars of the government's fiscal and structural policy, is progressing well and will provide a substantial boost to the long-run growth potential. It could also (i) provide additional revenue from the entities that are to be reformed, (ii) make funds available that are currently being used to provide direct support for operations, and (iii) contribute to general economic growth by making more productive use of the capital stock of these enterprises as management and operating efficiency improve.29 ADB has provided considerable support to this government reform program since 2002 (footnote 24).

27 In particular, (i) the public financial management framework does not include an internal audit function; (ii) no

integrated payroll system is in place (the Public Service Commission and the Treasury maintain separate payroll systems); (iii) noncompliance with internal controls for general expenditure is widespread within most ministries; and (iv) draft procurement legislation and regulations have yet to be enacted, and without these, new procurement procedures are not being implemented effectively.

28 ADB. 2008. Transforming Tonga: A Private Sector Assessment. Sydney and Manila. See also ADB. 2009. Special Evaluation Study: ADB’s Support for Public Sector Reforms in the Pacific: Enhancing Results through Ownership, Capacity, and Continuity. Manila.

29 Results achieved in the past 2 years include the rationalization of three public enterprises: Leiola Duty Free (privatization in 2008), Westpac Bank of Tonga (divestiture of a minority shareholding in 2008), and Tongatapu Machinery Pool (liquidation in 2008); a number of ongoing preprivatization restructurings as well as the progressive adoption of the 2006 policy to phase out all government ministers and public servants from public enterprise boards.

11

32. The benefits to government of continuing the public enterprise reforms are significant. Public enterprises control 14%–22% of total fixed assets within the economy, yet contribute just over 6% to GDP (footnote 1). Tonga’s public enterprises currently achieve an overall return on average equity of 3.6%, well below the 10% target return on equity set by the Government. If the total equity now invested in the operating public enterprises (around T$190 million) could achieve the target return on equity, and if other measures relevant to the reform of public enterprises can be implemented, the benefit through public enterprise reform to the government could be as high as T$17 million per annum, in present value terms (equivalent to over 2% of GDP). Further information on public enterprise performance is in Appendix 5. 33. The Government has also taken public service reform measures to establish the institutional framework for a more performance-oriented public service. The Public Service Commission has launched comprehensive public service remuneration reform commencing in FY2010. The main provisions are (i) a significant cut in annual and sick leave provisions (which were among the most generous in the region, if not internationally); (ii) a 10% across-the-board salary and wage increase for all public sector employees (para. 24); (iii) an increase in the government employer contribution from 7.5% of salaries and wages to 10%;30 (iv) a biennial performance-based review of public service remuneration; and (v) provision of a fixed salary ceiling for government departments that cannot be exceeded, and prohibition for the creation of new positions without Public Service Commission approval. 34. These civil service reform measures are a continuation of the reforms initiated in 2002, with ADB support, but interrupted by the 2005 strike and 2006 civil disturbances.31 They are designed to improve the productivity of the public service, make it more professional, and ensure that dissatisfaction due to erosion of salaries and wages arising from a failure to adjust wages and salaries on a regular basis does not lead to a repeat of the damaging strike by civil servants (Appendix 5). It will be vital for the Government to ensure that implementation of these reform measures is well managed, with a view to rapidly achieving productivity gains and budgetary savings, as staff reductions will materialize over time. The government could also consider reducing wage increases, or spreading the increase over time to reduce pressure on the FY2010 budget.

4. Protecting the Vulnerable

35. Tonga has long achieved universal primary enrollment; the majority of students continue to secondary education. Investment in education has been given a high priority, and accounts for a large share of total recurrent government expenditures. Over the past 3 years, spending per student in government middle and secondary schools increased by over 50%. The national health system provides a program of primary health care, which promotes universal accessibility, acceptability, appropriateness, and affordability. As a result, the Government provides most health services free of charge to Tongan citizens, and nearly the entire population has access to medical services through the national hospital on the main island of Tongatapu, district hospitals in the three main island groups, and 13 health centers around the country.

30 As scheduled in the 1999 Retirement Fund Administration Regulation. 31 ADB. 2002. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the

Kingdom of Tonga for the Economic and Public Sector Reform Program. Manila (Loan 1904-TON[SF], $10 million, approved on 28 May).

12

36. Given this good performance, the goal of social protection policy is to enhance current programs and develop new ones to cushion the impact of the crisis on the most vulnerable members of Tongan society (Appendix 6). Securing basic health and education, and providing opportunities by promoting economic activity across the more remote regions are important pillars of the strategy. While Tonga has relatively high human development indicator scores, the Government is committed to improvement. 37. Partnerships with development partners and innovative approaches have provided strong outcomes in the health and education sectors. These provide a strong foundation for protecting the vulnerable as the impacts of the crisis are felt:

(i) In line with the Eighth Sustainable Development Plan32 the Ministry of Health has made efforts to redirect the health budget to primary and preventative services, ensuring service provision at rural and regional health centers is protected.33 The ministry emphasizes strengthening its performance management systems. It prioritizes the development and operation of information systems, and monitors the utilization and quality of the information collected.

(ii) The Ministry of Education, with the support of the New Zealand Agency for International Development and the World Bank, has a school grants program34 that provides grants to all primary schools35 to help them meet minimum service standards by funding teaching materials, repairs and maintenance, and fixed assets. Grants comprise base and per pupil amounts. Grants are allocated according to a formula that reflects school size, location, remoteness, and a socioeconomic factor (based on household income earning index from the census). This has the effect of channeling more resources to schools in areas where students tend to come from vulnerable populations.

38. The Government provides free education (to secondary) and basic health services; this is an important component of social welfare in Tonga. The Government has been supported by high development partner support to these sectors. Nonetheless recognized gaps remain, for example, palliative care, services for the disabled (including access to education), and support for the mentally ill, which the Government has been unable to fund. Social protection is largely a community responsibility; however, changing demographics and migration are putting pressure on traditional assistance structures. 39. The Government is also developing a community development program to promote more equal regional and local economic and social opportunities. It aims to make local governance structures more responsive to the needs of the people. It foresees the devolution of decision-making and responsibilities in local and regional developments, and will focus on developing functional government systems (in regions, districts, towns, and villages), and encourage local authorities to develop rural services. 40. The Government recognizes that securing basic health and education, and providing opportunities by promoting economic activity outside urban areas are important pillars of the social protection strategy. 32 Government of Tonga. 2006. Kingdom of Tonga: Strategic Development Plan Eight 2006/07–2008/09. Nuku'alofa. 33 Government of Tonga. 2008. Report of the Minister for Health for the Year 2007. Tongatapu. 34 Ministry of Education, Women's Affairs and Culture. 2008. School Grants Operation Manual 2009. Tongatapu. 35 Latter Day Saints primary schools are excluded as these schools are already in receipt of sufficient funding, to

enable minimum service standards to be met or surpassed. Nongovernment schools catering to forms 1–2 (secondary) also receive grants.

13

41. Appendix 7 provides an analysis of the government response to the global economic crisis.

III. THE PROPOSED PROGRAM

A. Impact and Outcome

42. The program will contribute to achieving higher and more inclusive economic growth in Tonga. The main outcome will be a timely and effective response to the global economic crisis by providing budget support to finance the deficit forecast for the FY2010 budget. This will enable the government to implement an appropriate package to promote growth, continue structural reforms to strengthen foundations for growth, and protect the most vulnerable parts of society from the impact of the economic crisis. B. Policy Framework, Outputs, and Actions

43. The program outputs are (i) budget support to protect expenditure on basic social services for the vulnerable, (ii) maintenance of fiscal responsibility, (iii) structural and governance improvements, (iv) support to the vulnerable through targeted actions, and (v) communication and ownership of economic and fiscal management initiatives. The development policy letter and policy matrix are in Appendix 2. 44. Output 1: Budget support to protect expenditure on basic social services for the vulnerable. FY2010 budget revisions forecast a deficit of T$42.1 million (10.3% of GDP), if no steps are taken to contain expenditure. The grant will partially fund this gap, and thus support planned expenditure to address the impacts of the crisis. In determining how best to reduce expenditure, the following principles will guide decisions:

(i) expenditure on essential social services (including primary education and basic health services) will not be cut; and

(ii) savings will be made through a planned and strategic reduction in low value-added current expenditure.

45. Efforts to better understand and track expenditure on basic social services will be supported by an expenditure tracking system (para. 58) and analysis of this information. A key issue in social sector expenditure is achieving an appropriate balance between wage and salary expenditure and nonwage and salary expenditure. The Government intends to ensure nonwage and salary expenditure on basic social services is maintained. 46. The potential for capital investment to stimulate growth, through short-term job creation and in the medium term improving the operating environment for the public and private sector, can be realized once development partner funds are channeled through the budget. The ongoing efforts of the Ministry of Finance to bring development partner funds on-budget will allow the Government a clearer understanding of its capital investment position. The commitment to a prioritized medium- to long-term infrastructure investment plan (output 3) will reinforce the need for a clear presentation of capital investment through the budget.

14

47. Output 2: Maintenance of fiscal responsibility.36 The 2007 PEFA provided guidance for public financial management reform efforts. In particular, the Government focused on timely preparation of public accounts and initiated a move to a medium-term budget framework (para. 29). On the revenue side, in 2008, Tonga put in place new income tax and customs legislation. The simplified taxation system creates fewer distortions and is simpler to apply. 48. As part of the program, the Government will complete a second PEFA in 2010. This will record progress since the 2007 PEFA and identify priority areas for action. The results of the PEFA will be publicly released, and contribute to improved transparency in public financial management in Tonga. The Government will also commit to implementing a number of PEFA-related improvements during the program period, including approval of regulations for public procurement under the Public Financial Management Act, completion of the Treasury instruction and Treasury manual, and establishment of an internal audit unit within the Ministry of Finance to strengthen financial management. 49. The Government sees benefit in more rigorous and transparent use of the concept of operating parameters, around measures of capital expenditure and maintenance, government personnel costs, other (nonpersonnel) operating costs, and debt. The intent of such financial ratios is to promote fiscal sustainability over the medium term. The program provides for an ERC commitment to develop these as practical management tools for fiscal responsibility. ADB will assist Tonga in developing these ratios through the Pacific Economic Management TA.37 These ratios will then be included in the budget guidelines for FY2011, provided to ministries at the outset of the budget cycle, and used in setting the parameters for the FY2011 budget. The FY2011 budget will contain 3-year macroeconomic and revenue forecasts to better support a medium-term budget perspective. 50. The program will contribute to the strengthening of the budget process through the creation of a macroeconomic technical committee reflecting senior membership from key economic agencies in Government (Ministry of Finance, NRBT, Department of Statistics, and the Prime Minister's Office). This committee will meet regularly, at least quarterly, and work to improve the quality of economic forecasts and macroeconomic analysis being supplied to the ERC (through the minister of finance) and hence used in the budget development process. This process of quality assurance will encompass the model being used, the assumptions made regarding likely scenarios, and a shared understanding of the purpose and use of the forecasts. The creation of a committee with formalized terms of reference and meeting process also provides for greater accountability for decision making. Increasing the number of stakeholders involved in the development of forecasts is expected to more effectively utilize strengths available within various agencies, recognizing the human resource capacity constraints generally faced in Tonga. While the committee's initial focus will be improved rigor of forecasting, the membership of the committee provides more generally for strengthened economic policy analysis and advice to the ERC through the minister of finance, and hence used in the budget development process. The minister of finance recognizes this as a useful role. 51. Related support is already being provided through TA (footnote 37) to strengthen ERC operations by clarifying its mandate and criteria for considering expenditure decisions. This is

36 The public financial management-related reform measures are harmonized with the public sector reform

component of the Tonga–Australia Partnership for Development. The Australian Agency for International Development is providing implementation support to several of these measures.

37 ADB. 2009. Technical Assistance for Pacific Economic Management. Manila (TA 7280-REG, subprogram 1).

15

expected to create an environment in which the ERC will seek specific macroeconomic policy analysis and recommendations, and the macroeconomic technical committee will be well placed to respond. The TA will also enable mentoring of the macroeconomic technical committee as it takes on these new roles and responsibilities. 52. The program will support the development and implementation of a debt risk management and mitigation policy and strategy. The intent is to help the government move to more sustainable debt and to ensure that financial risks are prudent. The policy and strategy can also be potentially used to facilitate dialogue on the use and scope of debt management tools and their capacity for integration with other financial planning and management tools. The policy and strategy will be inclusive of

(i) processes by which guarantees and debt are analyzed before being agreed to;

(ii) processes and responsibilities for approval of new debt;

(iii) consideration of interest rate and foreign currency risks of existing and proposed new debt;

(iv) clear presentation of debt and planned debt payments in the annual budget;

(v) strengthened coordination between the Ministry of Finance and National Planning and other stakeholders in the issue of public debt;

(vi) debt repayment priorities;

(vii) processes for scheduling debt repayment;

(viii) a schedule of timely and standardized reporting on the government’s debt portfolio; and

(ix) regular updating of the debt strategy for fiscal results and its alignment with the fiscal and macroeconomic forecasts in the budget.

53. Output 3: Structural and governance improvements. This component of the program will ensure the continuation of the government's planned and ongoing structural reforms, which are geared to improving the productivity of the economy and placing it on a sustainable, private sector-led growth path over the medium term. Initiatives under way focus on accelerating public enterprise reform to reduce fiscal constraints and improve the productivity of public enterprises, as well as to modernize the commercial legal framework. 54. The public enterprise reform actions seek to improve efficiency and reduce the drain on the budget and the economy. It will also seek to achieve some "quick wins" in terms of boosting economic growth in the short to medium term. This will be achieved by (i) strengthening public enterprise governance through the appointment of an increasing number of directors selected from a pool of trained private sector professionals, and an amendment to the Public Enterprise Act, which will enhance the commercial governance practices of the public enterprises, as well as strengthen the monitoring framework; and (ii) enhancing the performance of public enterprises through a rationalization process and the promotion of private sector participation. 55. The program will help strengthen the laws and regulations under which businesses in Tonga operate, so reducing the cost of doing business and improving access to finance. The main target reforms are (i) amendment of the Companies Act, 1995, making it more suitable for companies that do business in Tonga;38 (ii) establishment of a new companies registry, which 38 The Companies Amendment Act was passed in September 2009.

16

will replace the paper registry destroyed by fire during the civil disturbances in 2006 (combined with the amendment to the Companies Act, 1995, it will make the process of company registration simple and fast); and (iii) Companies Act regulations. The program will help improve access to finance by reducing the risks of both lending and borrowing. These reforms will be put in place through a new personal property securities act, which will facilitate the use of chattels as collateral for loans. 56. The Government will finalize and implement a medium- to long-term prioritized infrastructure investment plan, and, through this, seek to identify and promote opportunities for public–private partnerships. Such a plan will promote greater development partner alignment with country needs and improved coordination and sequencing of public investments. It will also support a clearer budgetary presentation of the government's capital investment expenditure. 57. Output 4: Support the vulnerable through targeted actions. The Government is already directing considerable financial resources to the social sector, which provides services used by the vulnerable (and this expenditure is protected under output 1). However, the Government recognizes that areas for improvement remain in the priority setting, targeting, and delivery of such services to ensure the needs of the vulnerable are met. There are some initial steps that Government is taking in this area. 58. The Government will commission an expenditure tracking system for health and education. This will provide the information for improved decision making regarding targeted expenditure. In parallel, the Ministry of Health will undertake and commence implementation of a targeted review of existing facilities and equipment to ensure that these support the provision of services in the outer islands and districts and community health centers. This supports its goal of providing appropriate services to all the outer island districts and community health centers through effective resourcing, particularly important given that almost two-thirds of the population lives outside urban areas. 59. In continuing to address the specific needs of vulnerable populations, the Government will adopt and put in place the delivery structures for a new community development program, the goal of which is to reduce hardship and poverty by strengthening communities, civil society groups and organizations, and government to work in partnership to identify, prioritize, and address their own development needs. The program will support the participatory development of village, town and district 3-year rolling development plans utilizing democratic tools such as matrices and ballots, and empower district and town officers to implement the prioritized activities. 60. The community development program being implemented is a form of community-driven development (CDD) as it gives control of decisions and resources to community groups. CDD treats vulnerable people as assets and partners in the development process, building on their institutions and resources. Experience demonstrates that by directly relying on vulnerable people to drive development activities, CDD has the potential to make poverty reduction efforts more responsive to demands, more inclusive, more sustainable, and more cost-effective than traditional centrally led programs. Support to CDD usually includes strengthening and financing inclusive community groups, facilitating community access to information, and promoting an enabling environment through policy and institutional reform. These are elements of the Tongan community development program design. 61. The CDD program intends to support community residents in analyzing their situation and setting their priorities, developing their project management capacity, and developing some

17

skills in monitoring and evaluating their development programs. Program design was informed by a set of guiding principles inclusive of (i) poverty and hardship focus; (ii) self-reliance and ownership; (iii) participation; and (iv) women, youth, the poorest households, and remotest communities. Priorities for the scheme are income-generating activities and youth activities, though the scope of activities eligible for funding includes community development, women, health, and education activities. Funding for activities will be provided through the community development committee. 62. The expenditure tracking and CDD program are likely to provide information useful to strengthen policy formulation. However, these actions are first steps and no readily available information identifies vulnerable groups within the population, nor provides an understanding of how well traditional social safety nets are responding to, and withstanding, demographic and economic changes within Tongan society. The result is that social policy is not based on a rigorous analysis of the current situation. The program will support the development of an issues paper on vulnerable persons for the Cabinet's consideration. The cabinet paper will include identification of vulnerable groups, adequacy of existing social safety net systems, and options for enhanced social protection policies. In this respect, the program has markedly raised the profile of social protection and social welfare as concerns of the government. 63. Output 5: Communication and ownership. Lessons from ADB experience point to the importance of communication, consultation and ownership in economic reform. The development of local awareness, understanding, and ownership of programs are important success factors. The Government, through the Ministry for Finance and Planning, will therefore develop and deliver a communications strategy that will describe the government’s response to the global economic crisis. This will form the basis for consultation with stakeholders on these issues, and in the medium term will provide a model for seeking feedback to the policy formulation process. 64. The program supports the public release of external and independent reports on the Tongan economy and public financial management issues, in particular, the 2009 IMF Article IV staff report and the second PEFA. The Government has committed to publishing public enterprise performance data for FY2009. Such public release of information enables informed stakeholder dialogue on key economic issues. C. Lessons

65. The design of the program incorporates lessons from ADB’s experience in policy-based lending in the Pacific and elsewhere (Table 2).39 D. Important Features

66. Rapid response to global economic crisis. The program provides quick-disbursing budget support to allow the Government to effectively respond to the economic, fiscal, and social impacts of the crisis. The Government is increasing revenue efforts and reviewing expenditure to identify potential budget savings.

39 Key sources of lessons are: ADB. 2009. Special Evaluation Study: ADB’s Support for Public Sector Reforms in the

Pacific: Enhance Results through Ownership, Capacity, and Continuity. Manila; ADB. 2001. Special Evaluation Study on Program Lending. Manila; ADB. 1999. Reforms in the Pacific: An Assessment of the Asian Development Bank’s Assistance for Reform Programs in the Pacific. Manila.

18

Table 2: Lessons from Policy-Based Lending in the Pacific Main Lessons from Prior Policy-Based Operations in the Pacific

Manner in Which the Economic Support Program Incorporates the Lessons

The Government must "own" the program—it should not be seen as ADB's program.

The Economic Support Program (ESP) policy actions are aligned to current government policy while seeking to strengthen resolve, and accelerate the pace and depth of reform through the program. Close dialogue with both politicians and officials during preparation has tested and confirmed ownership.

Reforms must be politically as well as technically feasible.

The program was developed in close consultation with the most important political stakeholders—the Prime Minister and the minister of finance. One or the other of these signed each of the three memoranda of understanding agreed during processing. The program team has carefully considered the conditions from the perspective of political feasibility and degree of alignment with stated and actual government policy. An important means of generating wider public support for reform is to balance the "pain" (i.e., costs) with "gain" (i.e., benefits). In this regard, the output class on support to the vulnerable through targeted actions has both direct benefits to the vulnerable themselves as well as political benefits from the public support generated.

Avoid complexity. Excessive use of conditionality is not an effective approach to managing the reform process.

A focused set of program policy actions was selected that conforms with this lesson. The aim is to select a limited number of conditions that are expected to have a far-reaching effect within the Tongan context.

The importance of effective communication to build understanding and hence support for reform in the wider community.

The ESP includes an output class on communication and ownership of economic and fiscal management initiatives. Policy dialogue will continue to emphasize the political benefits of greater transparency.

Reform can take time to become self-sustaining—hence, support may need to be provided over a considerable time and involve a mix of lending and/or grants, technical assistance, and policy dialogue.

While the ESP is in part a response to the global economic crisis, it builds upon and extends more than 5 years of engagement by ADB with the Government of Tonga in support of reforms in economic, fiscal, and public sector management. Implementation of the ESP will be supported by both country and regional technical assistance. Through its headquarters and field-based personnel (including in Tonga itself), ADB is well placed to engage in dialogue at the political level, and to provide mentoring and capacity development assistance to officials. Technical assistance already approved or shortly to be approved will extend well beyond the ESP period. ADB has developed the ESP in close coordination with other development partners most interested in the areas covered by the program to ensure that complementary support is provided.

The existence of "champions for change" and "a window of opportunity" were identified as important factors contributing to the success of policy-based operations.

Tonga has strong champions for the ESP, while the global economic crisis has provided a window of opportunity to leverage an accelerated rate of reform and more fundamental reform than might otherwise have been the case.

Source: Asian Development Bank. 67. Structural reform. The program will leverage continuation of public sector and private sector development reform at a time when priority accorded to such reforms could be reduced.

19

The reforms are underpinned by significant analytical work and ongoing technical engagement and dialogue, especially in the areas of fiscal policy and infrastructure, and structural reform. These are based on the existing partnership between Tonga and ADB in these areas. It links into partnerships with other development agencies, in particular with the Australian Agency for International Development and the New Zealand Agency for International Development in public sector reform and the International Finance Corporation in private sector development (Appendix 8). The program builds on government reforms and reinforces ADB's role as a major partner in responding to Tonga’s development needs, including rapid crisis response, and in supporting economic and social development and reform. For its part, the Government has committed to a prudent response to the crisis, while leveraging the program as an opportunity to implement reform to transform the growth path of Tonga's economy in the longer term. Toward this end, the program provides the necessary fiscal resources, focus, and discipline for the continued implementation of important reform measures. 68. Leveraging social protection initiatives. The program provides an anchor for a proposed regional project, for financing by the Japan Fund for Poverty Reduction, designed to strengthen the resilience of the vulnerable through social impact analysis; identification and assessment of targeted rapid response measures such as cash for work and cash transfer programs; piloting of targeted social protection programs; support for nongovernment organizations’ activities to protect the vulnerable; and monitoring and evaluation of the impact of such activities (para. 87). 69. Postprogram monitoring framework. The program contains reform measures, the implementation of which will mostly require at least a medium-term horizon to fully achieve the intended outcomes. The Government and ADB have, therefore, agreed on the medium-term program directions set out in the policy matrix and their linkages to the National Strategic Planning Framework (Appendix 2). These will form the basis for the development of a postprogram monitoring framework to maintain reform momentum and focus dialogue and reform commitment through the medium term. The process will be supported by ongoing and forthcoming ADB TA (paras. 83–87). 70. Aid coordination. The formulation and delivery of ADB’s country partnership strategy and the program in general, and the crisis response in particular, has been coordinated and aligned with other development partners. Other development partners involved by the Government in the crisis response include Australia in the areas of infrastructure development and public sector reform; New Zealand in social sectors and planned business development services; the People's Republic of China, Japan, and the European Commission in infrastructure development; the World Bank in transport; the International Finance Corporation in private sector development; and IMF through the Pacific Financial Technical Assistance Center in economic statistics and surveillance. In terms of the proposed program, close coordination has been undertaken especially in the areas of public financial management with Australia (which features high in the Tonga–Australia Partnership for Development Agreement);40 and the IMF and the Pacific Financial Technical Assistance Center in the course of the Article IV surveillance mission and analytical work on economic and fiscal policies. A development coordination matrix is in Appendix 8.

40 In particular, the program's policy matrix in the area of public financial management is aligned with the Tonga–

Australia Partnership for Development, which will facilitate coordinated or joint dialogue and monitoring in this area.

20

E. Financing Plan

71. The Government has requested a grant of $10 million equivalent from ADB’s Special Funds resources to support its response to the crisis. In determining the grant size, consideration included the following: (i) the crisis has already caused a substantial deterioration of the fiscal situation in Tonga, while requiring policy measures to improve productivity, and protect the vulnerable; (ii) the global nature of the crisis implies downside risks to the socioeconomic situation in Tonga that, in turn, require preventive policy measures; (iii) the Government's commitment to a significant economic and public sector reform agenda is high and represents an opportunity for change; and (iv) the implementation of these reform measures will have structural adjustment cost implications. F. Implementation Arrangements

1. Program Management 72. The Prime Minister's Office (PMO) is the executing agency and will assume overall responsibility for program implementation, including coordination of the policy reform measures undertaken under the program. The PMO will ensure that the policy reforms, as agreed to by ADB and the Government and as described in the development policy letter, are duly carried out in a timely manner. Program coordination will be the responsibility of the chief secretary and secretary to cabinet under the PMO, supported by the PMO’s Advisory Unit. The chief secretary and secretary to cabinet will (a) ensure close coordination with other relevant ministries and government agencies; (b) take into account and address capacity issues in implementing ministries as they occur, to ensure the timely implementation of the program;, and (c) engage other stakeholders and raise awareness in the wider public domain on matters related to the Program. 73. The Ministry of Finance and National Planning; the Ministry of Public Enterprises; the Ministry of Labor, Commerce and Industry; and the Ministry of Health will be the main implementing agencies. The ERC, chaired by the Prime Minister, will function as the steering committee for the program, providing guidance for program implementation and coordination, and will meet on monthly basis to discuss the progress of the Program.

2. Implementation Period

74. Reforms supported under the program commenced in July 2008 and are expected to be completed by November 2010. The program will be completed 18 months after grant effectiveness, taking into account the audit and reporting requirements.

3. Procurement

75. Grant proceeds will be used to pay for items procured in ADB member countries, other than the items specified in the list of ineligible items (Appendix 9) and imports financed by other bilateral and multilateral sources.

4. Disbursement Arrangements

76. The proceeds of the program grant will be disbursed in accordance with the provisions of ADB’s simplification of disbursement procedures and related requirements for program loans and grants. Grant proceeds disbursed against imports will require a certificate from the

21

Government stipulating that the volume of eligible imports exceeds the amount of ADB's projected disbursements under the grant for the given period. ADB reserves the right to audit the use of grant proceeds to verify the accuracy of the government’s certification.

5. Anticorruption Policy

77. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the Government and the executing agency. Consistent with its commitment to good governance, accountability, and transparency, ADB reserves the right to investigate, directly or through its agents, any alleged corrupt, fraudulent, collusive, or coercive practices relating to the program. To support these efforts, relevant provisions of ADB’s Anticorruption Policy are included in the grant agreement. In particular, all contracts financed by ADB in connection with the program will include provisions specifying the right of ADB to audit and examine the records and accounts of the executing agency and all contractors, suppliers, consultants, and other service providers as they relate to the program.

6. Fiduciary Assessment

78. To address the perception of lack of transparency and accountability, the Government launched a series of reform measures, including introduction of the Public Financial Management Act, 2002 and associated reforms, establishment of an ombudsman and the Anti-Corruption Commission, and customs reform. Public procurement regulations are expected to be considered by the cabinet in December 2009. The program addresses anticorruption from several angles. The program strengthens overall public financial management. It includes measures to (i) improve procurement procedures, (ii) strengthen the quality of revenue information upon which expenditure decisions are based, and (iii) introduce medium-term macroeconomic forecasts within the budget. It draws heavily on the 2007 PEFA, and will include a PEFA update. This update will guide further development partner support. Moreover, the rationalization process of public enterprises, as supported under the program, including the removal of public servants and politicians as directors from public enterprise boards, is expected to reduce the exposure to vested government interests. The reform of the companies law and the new personal property securities framework will help strengthen governance as well.

7. Tranching and Counterpart Funds

79. The grant will be released in two tranches. The condition for effectiveness is that all first tranche conditions will have been met to the satisfaction of ADB. The first tranche ($5 million) will be released upon grant effectiveness. The second tranche ($5 million) will be released as soon as ADB is satisfied that the Government has made sufficient progress in implementing the program, particularly that all the second tranche conditions indicated in the policy matrix have been met. The indicative timing for release of the second tranche is November 2010. Therefore, the grant proceeds are expected to be fully utilized by December 2010. 80. The Government will ensure that the local currency funds generated by the grant will be used to support implementation of structural and public financial management reform measures, and protection of core social expenditure.

8. Accounting, Auditing, and Reporting

81. The Government will submit to ADB (i) semiannual reports on program implementation and accomplishments of the measures set forth in the development policy letter and the policy

22

matrix, which will describe progress made, any problems encountered, and remedial actions taken; and (ii) a program completion report within 3 months of program completion.

9. Program Performance Monitoring and Evaluation

82. The Government and ADB will monitor progress of program implementation closely. Review missions will be undertaken prior to the second tranche release to assess status and progress in accomplishing second tranche release milestones. Regular review missions during program implementation and thereafter until program completion will be undertaken with a view to measure progress against short- and medium-term targets. Associated TA reviews will continue monitoring beyond the lifetime of the program, ensuring the maintenance of the reform momentum. The Government, through the PMO, will establish and maintain a program performance monitoring system that will include a database on the status of policy measures and program indicators based on the policy matrix and the design and monitoring framework.

10. Technical Assistance

83. ADB has been providing substantial TA support to the Government in areas covered by the program, and will continue to do so during its implementation. The program, therefore, reflects continuity in ADB support for government reform priorities by addressing unfinished structural, public sector, and financial management reform. The ADB–World Bank Tonga country focal officer (funded by ADB under a regional TA),41 joint ADB–World Bank Country Focal Office, will provide an immediate point of contact as well as have relevant expertise to provide technical support as required. 84. In particular, under the Pacific Private Sector Development Initiative,42 ADB is supporting the PMO in the coordination of reforms related to private sector development and analysis of related issues and projects. The Pacific Private Sector Development Initiative is also supporting the contracting out of Ministry of Works’ road maintenance activities; reform of the Companies Act, 1995; and public enterprise director training and regional public enterprise benchmarking. Under TA for Reforming Public Enterprises, ADB is providing continued support for the rationalization of the public enterprise portfolio.43 85. Under the regional TA for Pacific Economic Management (footnote 37), ADB will provide monitoring and advisory support in relation to the crisis. The TA supports the strengthening of economic monitoring systems and using this information to provide higher-quality economic advice. The TA is focused on assisting in the formulation and implementation of country-specific actions in response to the global economic crisis. As required, assistance will be provided through this TA to support development of financial ratios and assessment of the impact of the global financial crisis on vulnerable groups. 86. A proposed 2009 TA for Tonga will provide support for economic and strategic management, in particular, help develop an economic and revenue forecasting model, address weaknesses in public expenditure management, and operationalize the new National Strategic Planning Framework into ministry and department corporate plans. 41 ADB. 2009. Technical Assistance for Enhancing Engagement with Pacific Developing Member Countries (TA

6475-REG). Manila. 42 ADB. 2006. Technical Assistance for the Private Sector Development Initiative. (TA 6353-REG). Manila. 43 ADB. 2009. Technical Assistance to the Kingdom of Tonga for Reforming Public Enterprises. Manila (TA 7271-

TON, $500,000, approved on 14 April).

23

87. A linked regional project—Supporting and Building Resilience of the Vulnerable—is proposed for grant financing from the Japan Fund for Poverty Reduction. It has the key objective of supporting the Government in assessing the social impact of the economic crisis, strengthening social protection policies, piloting social protection measures with potential for scaling up, and enhancing the capacity of nongovernment organizations in relation to social protection. As proposed, the linked project will provide Tonga with access to a selection of assistance including (i) a short-term response to the vulnerable (including unemployed youth, women, low-income households, and people with disabilities) to increase their economic status through cash-for-work and cash transfer programs; (ii) a pilot social welfare and social protection program, along with assessments of target groups and the feasibility of program types, and policy recommendations as long-term measures to strengthen the social safety net; (iii) support for nongovernment organizations and civil society activities for the vulnerable; and (iv) socioeconomic monitoring and evaluation of the situation of the vulnerable.

IV. PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS

A. Benefits

88. Economic. The program will provide budget support to enable the Government to respond to the economic downturn caused by the global economic crisis by stimulating the economy and maintaining essential services to the vulnerable population. In this way the program will support the recovery of the economy and contribute to the transition to higher and more inclusive economic growth. The decline of remittances, taxes, and duties as a result of the crisis has compressed the fiscal resources available to the Government so that without budget support, the Government would be unable to adequately respond to the crisis. 89. The Government wishes to undertake important reform measures in relation to fiscal and structural policies. The program will help address the prime causes of low productivity within the Tongan economy: the crowding out of private sector activity by public enterprises, the low rate of return on assets controlled by public enterprises, and the challenging business environment faced by the private sector. Reforms in public enterprises will deliver the higher-quality and lower-cost services needed for economic growth, and provide opportunities for local businesses to participate in service delivery. A number of the proposed reform measures will be important milestones in the ongoing public service reform process. 90. Social. The program will provide the necessary resources to maintain essential social expenditure, which would otherwise be vulnerable to reduction as a result of budgetary pressures. The program will also provide the necessary resources for the Government to deliver projects and programs targeting rural communities. An analysis of vulnerability issues is in Appendix 6. Government's proposed capital investments, will, to the extent possible, seek to maximize local labor content to create employment opportunities. Women will particularly benefit from the program, given their vulnerability to the economic crisis; they will benefit from protected social government expenditure, and community development programs that will help boost youth and female employment. 91. The legal reform components of the structural reform package should improve women’s access to commercial activities by simplifying procedures for women’s groups to incorporate companies, and allowing women to incorporate companies more quickly and inexpensively. In addition, the proposed secured transactions bill will provide women with greater opportunity to borrow against a range of personal assets which, currently, is either not possible legally or is prohibitive because of the transaction costs.

24

92. The program will help the Government develop its understanding of vulnerable groups within the population and the effectiveness of existing social safety net systems. This will prepare for consideration of a greater role for government in providing targeted social welfare assistance. The summary poverty reduction and social strategy is in Appendix 10. 93. Financial. The program will encourage improved fiscal management and budgeting focus on priority expenditures. A progressive increase in user charges for infrastructure services and preventative maintenance will remove unnecessary costs from the government budget. Improved returns from public enterprise assets will give more space in the budget for the government’s social and development spending. B. Risks and Mitigating Measures

94. The program is built around the government's commitment to address the crisis through exerting budgetary prudence, maintaining essential social expenditure, and continuing with its far-reaching structural reform program. The main risks relate to ownership, continued political support, and capacity. 95. Ownership. Lack of program ownership within the Government, the bureaucracy, or the community may reduce internal pressures to promote program implementation, or may even work actively against its implementation. This risk is mitigated by the fact that the elements of the program are not new issues for the Government. Indeed the program policy actions are aligned to current government policy, and build upon and extend more than 5 years of engagement by ADB with the Government in support of reforms in economic, fiscal, and public sector management. As a result, the Government has strong champions for the program, particularly the minister of finance, who is also the minister of public enterprises. Close dialogue with both politicians and officials during preparation has tested and confirms ownership. The inclusion of a communications strategy within the program seeks to ensure the community is aware of the program and has sufficient information to understand its intended benefits. 96. The design of the program itself also acts to promote ownership. It meets clearly recognized public financial management needs and so promotes support from the bureaucracy. The design also aims to balance the costs with the benefits. In this regard, the output class on support to the vulnerable through targeted actions has both direct benefits to the vulnerable themselves, as well as political benefits from the public support generated. This balance works to generate wider public support for reform. 97. Political risk. As a result of ongoing political reforms, general elections scheduled for late 2010 are likely to lead to changes in the political landscape, which could potentially affect Government support for the program.44 The ongoing reform process, which continuously fuels the momentum for change in general, and includes a wide range of stakeholders, is partly addressing the risks of shifts in political attitudes and commitment. At the same time, the intent is that the program will be implemented by the time of the general elections, allowing the flow of expected benefits to act to reduce the risk of any program components being back.

44 The Constitutional and Electoral Commission, formed after the coronation of the current King in August 2008,

delivered its report on political reforms on 5 November 2009. The intention is that the general election scheduled for late 2010 will be conducted under a new system. This is expected to see a majority of members of Parliament elected by popular vote, the practical implication for the program may be a period of uncertainty with perhaps many inexperienced ministers.

25

98. Political commitment to private and public sector reform is high in Tonga. To date, the Government has demonstrated its strong determination to reform, through the outcomes achieved in the course of the public enterprise reform program. It has approved and launched several other private sector development reforms in the program output areas. Commitment will be maintained during the reform period. Progress in implementing reforms and achieving results, continued engagement, policy dialogue, and progressively more broad-based consultation and participation in the reform process will contribute to the momentum. 99. Capacity. A risk is that the Government may not have sufficient capacity to implement the program and absorb the substantial reform agenda. To reduce the risk posed by insufficient capacity, TA support to various program components is to be provided (paras. 83–87). Through its headquarters and field-based personnel (including in Tonga itself), ADB is well placed to engage in dialogue at the political level and to provide mentoring and capacity development assistance to officials. While political and institutional commitment support continuing the implementation of reforms, technical and especially managerial resources are in short supply. Government agencies have demonstrated sufficient absorptive capacity especially in structural reform, as demonstrated by recent progress. ADB developed the program in close coordination with other development partners to ensure that complementary support is provided. In particular, the program is harmonized with the activities of the Australian Agency for International Development in public financial management and the International Finance Corporation in the area of structural reform. 100. The program also relies on a positive response by the private sector to the structural reforms and improved global economic conditions. The capacity of the private sector to respond to opportunities presented through government expenditure, and governance and legislative changes to the operating environment are important to program success. Private sector response to the reconstruction measures has increased considerably since early 2009. 101. The program relies on (i) a positive response by the private sector to improved economic conditions; (ii) government agencies’ commitment to improved performance; and (iii) restraint by government agencies in increasing current expenditure, given their weak revenue performance. 102. Overall, the potential benefits from reducing the impact of the global economic crisis and providing for continued government expenditure on priority capital works and basic social services with supporting structural and governance initiatives are considered to outweigh the risks. Indeed, the costs of no action could be substantial. They would be reflected in a rapid decline in provision of government services with resulting negative effects on health and education, and constraints on the private sector.

V. ASSURANCES AND CONDITION A. Assurances 103. In addition to the standard assurances and the policy conditions set forth in the policy matrix, the Government has given the following specific assurances:

(i) The Government will (a) ensure that the policies already adopted and actions already taken as described in the development policy letter, including the policy matrix, continue in effect for the duration of the program period and subsequently; and (b) promptly adopt all other policies and take all other actions indicated in the development policy letter, including the policy matrix, and ensure that such policies and actions continue in effect for the duration of the program period and subsequently.

26

(ii) The Government will keep ADB informed of policy discussions with other multilateral or bilateral aid partners that have implications for implementation of the program, keep ADB informed of the progress made in carrying out the policies and actions set out in the development policy letter and the policy matrix, and provide ADB with an opportunity to comment on any resulting policy proposals. The Government will continue policy dialogue with ADB on problems and constraints encountered during implementation of the program and on desirable changes to overcome or mitigate such problems and constraints.

(iii) Throughout the implementation of the program, the Government will ensure that adequate resources are allocated and released in a timely manner in order to ensure proper implementation of the program as described in the development policy letter. The Government will ensure that the counterpart funds generated out of the grant proceeds are directed to fiscal, structural, and social protection policy measures as described in the development policy letter.

(iv) The Government will undertake necessary measures to create and sustain a corruption-free environment; ensure that its anticorruption law and regulations and ADB’s Anticorruption Policy (1998, as amended to date) are strictly enforced and complied with during the program implementation; and facilitate ADB to exercise its right to investigate, directly or through its agents, any alleged corrupt, fraudulent, collusive, or coercive practices relating to the program.

(v) The Government will ensure that (a) within 3 months of loan effectiveness, a performance evaluation system acceptable to ADB will be established and maintained that will include a database on the status of policy measures and Program indicators based on the policy matrix and the design and monitoring framework.

(vi) The Government will submit to ADB (i) semiannual reports on program implementation and accomplishments of the measures set forth in the development policy letter and the policy matrix, which will describe progress made, any problems encountered, and remedial actions taken; and (ii) a program completion report within 3 months of program completion. .

B. Condition for Effectiveness 104. Prior to the effectiveness of the Grant Agreement the Government will have complied with all the first trance conditions set out in the Policy Matrix.

VI. RECOMMENDATION

105. I am satisfied that the proposed grant would comply with the Articles of Agreement of the Asian Development Bank (ADB) and, acting in the absence of the President, under the provisions of Article 35.1 of the Articles of Agreement of ADB, I recommend that the Board approve the grant not exceeding $10,000,000 to the Kingdom of Tonga from ADB’s Special Funds resources for the Economic Support Program on terms and conditions that are substantially in accordance with those set forth in the draft Grant Agreement presented to the Board.

C. Lawrence Greenwood, Jr.

Vice-President 12 November 2009

Appendix 1 27

DESIGN AND MONITORING FRAMEWORK

Design Summary

Performance Targets/Indicators

Data Sources/Reporting Mechanisms Assumptions and Risks

Impact Achievement of a higher and more inclusive economic growth path

Real GDP growth progressively raised to a higher long-term growth rate (about 3% per annum)

Relative standard of living of the most vulnerable groups of the community improved as measured by the proportion of household income received by the bottom quintile of households

The proportion of the population living below the national poverty baseline is reduced

Budget papers, periodic household income and expenditure survey (forthcoming in 2009, and future surveys); periodic demographic and health survey; MDG reports

Assumptions Early international recovery from the global economic crisis, especially in major high-income partner countries

Private sector responds to improved economic conditions

Risks Additional external shocks weaken the economy

International oil prices rise rapidly

Outcome Timely and effective response to the global economic crisis

Positive economic growth in FY2010 (>0%) and FY2011 (>1.5%) Improvement in the business environment (Doing Business ranking improved. Baseline 2009 rank: 43) Maintenance of access and service standards on outer islands as evidenced by health and education and Public Service Commission administrative data

Budget papers World Bank Doing Business indicators 2010 and 2011 Education and health ministries and public service commission administrative data

Assumptions Government's continued commitment to the support program

Well-coordinated implementation of crisis response package

Sufficient private sector capacity and confidence to respond to policy reform measures

No sharp deterioration in the fiscal accounts

Outputs 1. Budget support to

protect the vulnerable

FY2010 budget allocation for basic health and primary education expenditure met in budget outturn

FY2011 budget papers

2. Maintenance of fiscal responsibility

Improved overall PEFA outcome (baseline 2007 report, new PEFA scheduled for 2010)

Strengthened reporting on debt in FY2011 budget

Reporting on financial ratios in FY2011 budget

2010 PEFA report FY2011 budget papers FY2011 budget papers

3. Structural and governance improvements

Improved governance arrangements in public enterprises, as indicated by (i) ministers and civil servants removed from at least 10 public enterprise

Public enterprise reports and board minutes

Parliament minutes

Assumptions Continued government commitment to the program

Sufficient absorptive government capacity to implement the program

Realistic time frame for implementation

Legislative assembly supports the passage of legislation

28 Appendix 1

Design Summary

Performance Targets/Indicators

Data Sources/Reporting Mechanisms Assumptions and Risks

boards, and (ii) the passing and enactment of the Public Enterprise Amendment Bill

Rationalization plans completed for at least three additional public enterprises

Improved business environment, as indicated by (i) the passing and enactment of a new Companies Amendment Bill; (ii) the companies registry has commenced operation (IFC-supported), and (iii) the passing and enactment of a new personal property securities act

Government reports, TA reports

Parliament minutes

Registry online, business registered, press releases

Parliament minutes

4. Support the vulnerable through targeted actions

Maintenance of access and service standards on outer islands as evidenced by health and education and Public Service Commission administrative data

Implementation of a new community program in at least two districts, with relevant community-based activities (subprojects) under way

Public expenditure tracking for health and education sectors

Financial and social government statistics; government budget; PMO report on community development, health, and education; Public Service Commission administrative data, public expenditure tracking reports

5. Communication and ownership of economic and fiscal management initiatives

Effective communications strategy in place explaining the government’s response to the global economic crisis

Government website, media presentation, press releases

Activities with Milestones Inputs Tranche 1 (December 2009) 1.1 The ERC commits to budget management principles 2.1 Public financial management reforms made in response to the 2007 PEFA 2.2 The ERC commits to second PEFA 2.3 Macroeconomic technical committee created 2.4 Commit to develop financial ratios by the end of December 2009 2.5 Cabinet approves development of a debt risk management and mitigation policy

and strategy 3.1 Rationalization of two public enterprises 3.2 Five public enterprise boards do not include ministers or civil servants as directors 3.3 Rationalization strategies completed for an additional three public enterprises 3.4 Companies amendment bill enacted 4.1 Cabinet adopts the community development program design document and 4.2 Community development program structures established in two pilot districts

ADB ADB program grant ($10 million) Government Reform action

Financing for capital expenditure

Counterpart support to TA

Appendix 1 29

Activities with Milestones Inputs 4.3 Ministry of Health commits to undertake review to ensure facilities and equipment

support provision of services in outer islands, and districts and community health centers

5.1 Cabinet endorses a communications and engagement strategy 5.2 Publish public enterprise performance data for FY2009 5.3 Release the 2009 IMF Article IV staff report to the public Tranche 2 (no later than November 2010) 2.1 Complete second PEFA 2.2 Implement improved processes for macroeconomic and revenue forecasting 2.3 Include financial ratios in program budget guidelines for FY2011 2.4 Ensure debt risk management and mitigation policy and strategy in use 2.5 Approve public procurement regulations 2.6 Treasury Instruction and Manual completed and commitment to establish an

internal audit unit 3.1 Ensure additional five public enterprise boards no longer include ministers or civil

servants as directors 3.2 Submit Public Enterprise Amendment Bill to Parliament 3.3 Submit Personal Property Securities Bill to Parliament 3.4 Implement Companies' Registry 3.5 Royal Assent to Companies Amendment Act and implement regulations 3.6 Cabinet approves prioritized medium- to long-term infrastructure investment plan 4.1 Public expenditure tracking system for health and education sectors commissioned 4.2 The Ministry of Health adopts action plan to implement recommendations of review

in action 4.2 in tranche 1 4.3 Cabinet considers an issues paper for vulnerable persons 5.1 Commence implementation of communication and engagement strategy 5.2 Publish FY2009 enterprise level performance data for public enterprises 5.3 Release the PEFA to the public

ADB = Asian Development Bank; ERC = Expenditure Review Committee; FY = fiscal year; GDP = gross domestic product; IMF = International Monetary Fund; MDG = Millennium Development Goal; PEFA = public expenditure and financial accountability assessment; PMO = Prime Minister’s Office. Source: ADB estimates.

30 Appendix 2

Appendix 2 31

32 Appendix 2

Appendix 2 33

POLICY MATRIX

Focus Area Policy Actions Prior to First Tranche Release

(December 2009) Policy Actions prior to

Second Tranche Release (Indicative by November 2010)

Medium-Term Program Direction

Output 1: Budget support to protect services to the vulnerable

1.1 The Government through ERC will have made a commitment to adopt the following principles in managing its FY2010 budget expenditure in light of reduced growth and revenue forecasts: • essential social services (including primary

education and basic health services) will not be cut; and

• savings will be made through a planned and strategic reduction, such as in low-value added current expenditure.

(Recorded in ERC minutes, and to be certified by ERC Secretariat to ADB)

Output 2: Maintenance of fiscal responsibility

2.1 The Government through Ministry of Finance and National Planning will have implemented public financial management reforms in response to the 2007 Public Expenditure and Financial Accountability Assessment (PEFA), so as to strengthen fiscal responsibility, including: • preparation of the FY2010 budget using a

medium term budget framework or multi year projects;

• existence of, and adherence to a budget calendar;

• public accounts are brought up to date; • bank reconciliations are completed on a

monthly basis; • commitment to establish a medium to long

term infrastructure investment plan; and • improvements in terms of tax registration

and collection of tax arrears.

2.1 The Government through Ministry of Finance and National Planning will have completed the second PEFA.

(To be certified by Minister for Finance and National Planning (MFNP) to ADB)

Improved fiscal disicpline

(National Strategic Planning Framework (NSPF)- Enabling theme 3: Improve the effectiveness of revenue collection to ensure a level playing field and that services to the people can be appropriately funded)

34 Appendix 2

Focus Area Policy Actions Prior to First Tranche Release(December 2009)

Policy Actions prior to Second Tranche Release

(Indicative by November 2010)

Medium-Term Program Direction

(To be certified by Minister for Finance and National Planning (MFNP) to ADB) 2.2 The Government through the ERC will have made a commitment to complete the second PEFA by June 2010.

(Recorded in ERC minutes, and to be certified by ERC Secretariat to ADB) 2.3 The Government through the MFNP will have created a standing Macroeconomic Technical Committee: • to include Secretary for Finance (Chair),

representative from the Reserve Bank, Government Statistician and representatives of Prime Minister's Office, and Policy and Planning (Secretariat) as member in order to more effectively utilize the strengths available within these various agencies;

• with a terms of reference including responsibility for monitoring the macroeconomic environment; developing macroeconomic forecasts; development, use and maintenance of an improved

2.2 The Government through the Ministry of Finance and National Planning will have operationalized improved processes for macroeconomic and revenue forecasting in which: • credible model for macroeconomic and

revenue forecasting in use • the Macroeconomic Technical Committee

meets quarterly and report against their terms of reference.

• 3 year macroeconomic and revenue forecasts presented in FY2011 Budget

(To be certified by MFNP to ADB and accompanied by copies of meeting agendas and copy of FY2011 Budget inclusive of forecasts)

2.3 The Government through the Ministry of Finance and National Planning will have met financial ratios set out in the Program Budget Guidelines for FY2011.

(MFNP to provide copy of Program Budget Guideline for FY2011 to ADB)

Appendix 2 35

Focus Area Policy Actions Prior to First Tranche Release(December 2009)

Policy Actions prior to Second Tranche Release

(Indicative by November 2010)

Medium-Term Program Direction

macroeconomic and revenue forecasting model; and advising the Minister for Finance on the above;

• which meets at least quarterly, and; • which has the overarching objectives of

improving the quality of economic forecasts and macroeconomic analysis being supplied to ERC and hence used in the budget development process.

(MFNP to provide the appointment letter for the establishment of the Committee, terms of reference, and confirmation of first meeting to ADB) 2.4 The Government through the ERC will have made a commitment to develop financial ratios by the end of December 2009, to promote fiscal sustainability over the medium term, in relation to measures of:

• capital expenditure and maintenance; • public debt; • government personnel costs; and • other (non-personnel) operating costs.

(Recorded in ERC minutes, and to be certified by ERC Secretariat to ADB)

2.5 The Cabinet will have approved the development of a debt risk management and mitigation policy and strategy, with the intent of ensuring debt is kept to sustainable levels, and which shall include:

2.4 The Government will have operationalized Cabinet-approved debt risk management and mitigation policy and strategy, which include: • processes and responsibilities for the

analysis and approval of proposed new guarantees and debt;

• processes for prioritizing and scheduling debt repayment; and

• a schedule of timely and standardized reporting on Government’s debt portfolio.

(Approval of strategy recorded in Cabinet minutes, and provision of reports on strategy implementation to be certified by Chief Secretary and Secretary to Cabinet (CSSC) to ADB) 2.5 The Privy Council will have approved the regulations for public procurement under the Public Financial Management Act.

(Recorded in Privy Council record, copies

36 Appendix 2

Focus Area Policy Actions Prior to First Tranche Release(December 2009)

Policy Actions prior to Second Tranche Release

(Indicative by November 2010)

Medium-Term Program Direction

• processes and responsibilities for the analysis and approval of proposed new guarantees and debt;

• processes for prioritizing and scheduling debt repayment; and

• a schedule of timely and standardized reporting on Government’s debt portfolio.

(Recorded in Cabinet minutes, and to be certified by CSSC to ADB)

of the draft regulations and paper supporting the submission and Privy Council record to be provided to ADB by Secretary for Finance) 2.6 The Government through the Ministry of Finance and National Planning (MoFNP) will have: • completed Treasury Instruction; • completed Treasury Manual; and • committed to establish an internal audit

unit within MoFNP to strengthen financial management.

(MoFNP to provide to ADB a copy of each of the instruction, manual and decree for the establishment of the internal audit unit).

Output 3: Structural and governance improvements

3.1 The Government through the Ministry of Public Enterprises will have privatized Leiola Duty Free Ltd. and liquidated Tongatapu Machinery Pool).

(Director for Public Enterprises to provide to ADB the documents that evidence the privatization and the liquidation process.)

3.2 The Government through the Ministry of Public Enterprises will have restructured at least five public enterprise boards to comply with the

3.1 The Government through the Ministry of Public Enterprises will have restructured five additional public enterprise boards to comply with the decision that Ministers, Members of the Legislative Assembly or civil servants should not serve as public enterprise directors.

(Director for Public Enterprises to provide to ADB the appointment letters of the boards in the additional five public enterprises) 3.2 The Government will have submitted to the Legislative Assembly the Public Enterprise Amendment Bill which:

Public sector productivity is improved and non-core functions are increasingly passed to the private sector.

(NSPF – Enabling Theme 2: Ensure state owned enterprises are accountable to government as owner and that they provide dividends for the benefit of the people in proportion to capital invested)

Appendix 2 37

Focus Area Policy Actions Prior to First Tranche Release(December 2009)

Policy Actions prior to Second Tranche Release

(Indicative by November 2010)

Medium-Term Program Direction

Government decision that politicians and civil servants should not serve as public enterprise directors.

(Minister for Public Enterprises to provide to ADB the appointment letters of the boards in five public enterprises, and to certify to ADB that these board members are not politicians and civil servant) 3.3 The Government through the Ministry of Public Enterprises will have completed and accepted the rationalization strategies for additional three public enterprises, being Waste Authority, Tonga Water Board and Tonga Power Limited.

(The Minister for Public Enterprises to provide to ADB the document of acceptance for the three rationalizations). 3.4 The Legislative Assembly will have approved the Companies Amendment Bill , which:

• enhances the commercial governance practices of public enterprises;

• strengthens the monitoring framework for public enterprises;

• formalizes the Government’s decision that politicians should not serve as public enterprise directors;

• establishes a principle objective for all public enterprises to operate as a successful business;

• clarifies the rules and processes associated with the approval of community service obligations;

• establishes clear guidelines on the selection and appointment of directors; and

• clarifies director accountabilities.

(Recorded in Legislative Assembly record, copies of the draft act and paper supporting the submission and Legislative Assembly record to be provided to ADB by Director for Public Enterprises) 3.3 The Government will have submitted to the Legislative Assembly the Personal Property Securities Bill which facilitates the use of chattels as collateral for loans

(Recorded in Legislative Assembly record, copies of the draft act and paper supporting the submission and Legislative Assembly record to be provided to ADB by Minister of Labour, Commerce and Industries) 3.4 The Government through the Ministry of

The business environment facilitates private sector growth.

(NSPF – Primary Outcome Objective 2: Support private sector growth through better engagement with government, appropriate incentives and streamlining of rules and regulations) The Infrastructure Investment Plan is maintained as rolling public investment plan in support of the National Planning Framework and guides all large-scale capital investment.

(NSPF – Primary Outcome Objective 4: Maintain and develop infrastructure to improve the everyday lives of the people)

38 Appendix 2

Focus Area Policy Actions Prior to First Tranche Release(December 2009)

Policy Actions prior to Second Tranche Release

(Indicative by November 2010)

Medium-Term Program Direction

• clarifies the law; and • simplifies procedures for incorporation.

(MFNP to provide copy of the enacted legislation)

Labour, Commerce and Industries will have operationalized the new Companies' Registry to make the process of company registration simple and fast, in line with the Companies Amendment Act.

(Minister of Labour, Commerce and Industries to certify to ADB) 3.5 The Government will ensure that Companies Amendment Act will have received Royal Assent and made effective the implementing regulations of the Act.

(Minister of Labour, Commerce and Industries to provide to ADB a copy of the royal assent and evidence on the effectiveness of the regulations) 3.6 The Cabinet will have approved the Government’s prioritized medium to long term infrastructure investment plan.

(Recorded in Cabinet minutes, and to be certified by CSSC to ADB)

Output 4: Support the vulnerable through targeted actions

4.1 The Cabinet will have adopted the community development program design document which has the goal of alleviating poverty and hardship at the community level through devolving decision making and responsibilities in local and regional development as a means to address more effectively community needs, promote self-reliance, and enhance service delivery in rural areas. The program design includes the following features: • strengthening and financing inclusive

4.1 The Government through the Ministry of Health and Ministry of Education will have commissioned the public expenditure tracking system for health and education sectors.

(To be certified by Minister of Health and Minister of Education to ADB)

Facilitate the move out of poverty by improving access to essential services by the most vulnerable.

(NSPF Vision – To create a society in which all Tongans enjoy higher living standards and a better quality of life through good governance, equitable

Appendix 2 39

Focus Area Policy Actions Prior to First Tranche Release(December 2009)

Policy Actions prior to Second Tranche Release

(Indicative by November 2010)

Medium-Term Program Direction

community groups; • facilitating community access to information;

and • promoting an enabling environment through

policy and institutional reform.

(Recorded in Cabinet minutes, and to be certified by CSSC to ADB) 4.2 The Government through the Prime Minister's Office will have established community development program structure and systems (including district offices, personnel, committees) in two pilot districts.

(CSSC to provide to ADB the legal instrument that establishes such structure and systems) 4.3 The Government through the Ministry of Health will have made a commitment to undertake, by December 2009, a review of existing facilities and equipment to ensure these support the provision of services in the outer islands and districts and community health centers.

(To be certified by Minister of Health to ADB)

4.2 The Government through the Ministry of Health will have adopted the action plan to implement recommendations of review of outer island districts and community health center services.

(To be certified by Minister of Health to ADB)

4.3 The Cabinet will have reviewed a Vulnerable Persons Issues Paper, which will include: • the identification of the vulnerable groups; • the adequacy of existing social safety net

systems; and • the options for enhanced social protection

policies.

(Recorded in Cabinet minutes, and to be certified by CSSC to ADB)

and environmentally sustainable private sector-led economic growth, improved health and education standards, and cultural development.)

Output 5: Communication and ownership of economic and fiscal management initiatives

5.1 The Cabinet will have endorsed a communications and engagement strategy which explains Government’s programmatic response to the economic crisis

(Recorded in Cabinet minutes, and to be certified by CSSC to ADB)

5.1 Government through the MoFNP will have commenced the rolling out of the communication and engagement strategy

(Progress report to be provided by MFNP to ADB)

Regular use of public communications by Government to raise awareness of its policy actions, and to receive and respond to feedback.

40 Appendix 2

Focus Area Policy Actions Prior to First Tranche Release(December 2009)

Policy Actions prior to Second Tranche Release

(Indicative by November 2010)

Medium-Term Program Direction

5.2 The Government through the Ministry of Public Enterprises will have published aggregated public enterprise performance data (using the most recent financial information available where FY2009 is not available) in a local newspaper in Tongan and English, comparing it with prior year results and explaining major trends.

(Media reports provided to ADB by Ministry of Public Enterprises)

5.3 The Government through the MoFNP will have released publicly the 2009 IMF Article IV Staff Report

(IMF website, www.imf.org)

5.2 Government through the Ministry of Public Enterprises will have published enterprise level performance data for the public enterprises for FY2009 following the tabling of the respective annual reports in the Legislative Assembly. (The Ministry of Public Enterprises to provide copies of Legislative Assembly record to show that the reports have been tabled) 5.3 The Government through the MoFNP will have released publicly the PEFA

(PEFA website, www.pefa.org)

Regional benchmarking of public enterprise performance.

(NSPF – Enabling Theme 2: Ensure state owned enterprises are accountable to government as owner and that they provide dividends for the benefit of the people in proportion to capital invested)

CSSC = Chief Secretary and Secretary to Cabinet (CSSC), ERC = Expenditure Review Committee; FY = financial year; IMF = International Monetary Fund; MFNP = Minister of Finance and National Planning, MoFNP = Ministry of Finance and National Planning, CSSC = Chief Secretary and Secretary to Cabinet, NSPF = National Strategic Planning Framework; PEFA = Public Expenditure and Financial Accountability Assessment Source: Government of Tonga.

Appendix 3 41

ECONOMIC ANALYSIS

A. Economic Performance

1. Tonga is a small open economy vulnerable to internal and external shocks. Real gross domestic product (GDP) growth averaged 1.8% per annum since 1999, well below the regional average of 3.2% (Figure A3.1). Economic activity has exhibited significant fluctuations in recent years as underlying structural constraints, political disturbances, and global economic developments have adversely affected growth. Following the civil service strike in 2005 and the civil disturbances at the end of 2006, the economy recovered strongly in FY2008 growing by 2.7% in real terms, the highest growth rate registered since FY2002.1

2. However, just as the long-term growth outlook for Tonga's economy began to improve, the economy was adversely affected by the sharp increase in the price of fuel and food in the second half of 2008 (Figure A3.1). The impact of the global economic crisis, which began to unfold at the end of 2008, further weakened economic activity. Exports and remittances 1 The quality of Tonga’s national accounts statistics is mixed. However, recent revisions to the national accounts,

with assistance from the Pacific Financial Technical Assistance Center, indicate that both nominal and real GDP is substantially higher than previously estimated. Nominal GDP has been systematically underestimated in the national accounts by an average of 20% during FY1994–FY2008, and real GDP by an average of 21.2%.

Merchandise imports

0

40

80

120

FY19

97

FY19

98

FY19

99

FY20

00

FY20

01

FY20

02

FY20

03

FY20

04

FY20

05

FY20

06

FY20

07

FY20

08

US$

mili

on

Tonga real GDP growth, FY1995-FY2009

-3

0

3

6

1994-95 1996–97 1998–99 2000–01 2002-03 2004-05 2006-07 2008-09

% p

er a

nnum

Real GDP Real GDP per capita

Source: Government of Tonga.

Figure A3.1: Economic Indicators

42 Appendix 3

declined because of weak demand and high unemployment in major source economies—Australia, New Zealand, and the United States. Real GDP growth in FY2009 fell sharply to an estimated 0.4%. The forecast is for low growth in FY2010. This recent weakening in the economy is against a background of a long-term deterioration in economic performance. As highlighted in Figure A3.2, since the mid-1990s the investment ratio has remained at approximately 20%. The savings ratio—which indicates the percentage of household disposable income that is saved—shows a more mixed performance, averaging 15% from FY1994 to FY2008. Productivity has also declined. Average labor productivity is now only slightly above what it was in the mid-1980s. Such developments point to deep weaknesses in the growth process.

Figure A3.2: Investment and Savings Trends

010

2030

40

FY19

94

FY19

95

FY19

96

FY19

97

FY19

98

FY19

99

FY20

00

FY20

01

FY20

02

FY20

03

FY20

04

FY20

05

FY20

06

FY20

07

FY20

08

Source: Government of Tonga.

% o

f GD

P

Savings ratio Investment ratio

B. Economic Prospects

3. Like most small open economies, Tonga is relatively undiversified. It is highly dependent on remittances and imports a substantial proportion of what it consumes. While agriculture and fisheries are still the largest contributors to overall output (averaging 20% of GDP over the last 5 years), their importance is diminishing as the services sector—led by communications and tourism—has grown sharply over the past 15 years. 4. The Strategic Development Plan Eight,2 covering FY2007–FY2009, established a target GDP growth of 5% per year or better, while the Government’s Economic and Public Sector Reform Program3 instituted in 2002, targeted growth rates of 3% per year or better. Hence, growth has been below target. Growth was expected to slow in FY2006, but the extent of the slowdown exceeded expectations. Growth fell to 0.3% in FY2006 and the economy contracted by 1.7% in FY2007. Because the size of the population remains relatively unchanged, the change in GDP per capita closely matches changes in aggregate GDP. 5. Agriculture, forestry, and fishing account for a quarter of GDP and industry developments have an important bearing on the growth outcome. Strong growth in fish and squash exports, which account for around 80% of merchandise exports, led to good growth in

1 Government of Tonga. 2006. Kingdom of Tonga: Strategic Development Plan Eight 2006/07–2008/09. Nuku'alofa. 2 Government of Tonga. 2002. Economic and Public Sector Reform Program. Nuku'alofa.

Appendix 3 43

agriculture, forestry, and fishing in FY2002–FY2003. However, the combined effect of a fall in export prices, rising costs, and unfavorable weather patterns (for fishing) have seen industry output subsequently contract. Export volumes of both commodities have fallen by about one-third. 6. Commerce, restaurants, and hotels experienced good growth to FY2005, although performance has been mixed since then (contracting by an average of 5.5% per year) as key drivers of growth—remittances, bank lending, and visitor expenditure—have eased. 7. Since 2000, tourism has been one of the most rapidly growing sectors of the economy, although it still accounts for less than 10% of GDP. The increase in the number of overseas flights (including those directly from Sydney, Australia), the development of an experienced domestic airline in 2007, and the inclusion of Tonga in the itinerary of cruise liners has substantially boosted visitor numbers and spending in recent years (although the spending per cruise ship tourist is lower than that for arrivals by air). Tourism arrivals by air rose nearly 22% in FY2008 and cruise ship visitors by 50%. Overall, tourism expenditure rose by nearly 60% over the same period. However, at the end of July 2009, tourist arrivals fell by 2.0% on a year-on-year basis and tourism spending contracted by 13.5%. C. Policy Priorities

8. For many years, Tonga followed an inward-looking approach to economic management. The chief demonstration of this approach was provided by the Government’s heavy reliance on trade taxes, notably import duties. Import duties tended to shelter domestic industries from foreign competition through tariffs, encouraging inefficiency while penalizing exporters. 9. An outward-looking approach to economic management was gradually adopted following the Economic and Public Sector Reform Program in 2002. Efforts initially focused on trade reform. Tonga sought accession to the World Trade Organization in the mid-1990s, a process that was completed in December 2005. As part of the accession, a consumption tax was introduced in April 2005 to replace most trade taxes. Tonga has also ratified the Pacific Island Countries Trade Agreement and the Pacific Agreement on Closer Economic Relations, and is negotiating an economic partnership agreement with the European Union. 10. Trade reform has been complemented by new foreign investment legislation. To date, foreign investment has been low—an outcome that in part appears to be a reflection of local wariness of the change that foreign investors can bring. Nevertheless, many policy makers recognize that foreign investment is essential to the realization of development goals set for the community. The new legislation came into effect in April 2007. 11. The transparency and predictability needed by the private sector was enhanced by the adoption of new business licensing legislation. A participatory approach is now in place with the private sector to continue regulatory reform. 12. One of the key areas to be addressed is access to land. Both local and foreign investment is constrained by the availability of land—the brevity of the leases by which it is made available, provisions for regular rent reviews, and the weak protection provided to investors. Land tenure systems are intimately tied in with the overall structure of society, and this makes it extremely difficult to bring land management into line with the needs of a market-based economy. Yet potential feasible areas of reform include revisions to the length of leases.

44 Appendix 3

13. The Government has been heavily involved in the provision of goods and services. Tonga’s public enterprises leave little opportunity for the private sector, and thus depress economic growth. Public enterprises control 14%–22% of total fixed assets within the economy, yet contribute just over 6% to gross domestic product. Tonga’s public enterprises currently achieve an overall return on average equity of 3.6%, well below the 10% target return. The economic value destroyed by the public enterprise portfolio in Tonga during FY2002–FY2006 is estimated to equal about half of the Government's total expenditure on health and education. As of 30 June 2009, 15 public enterprises were wholly owned by the state. They are involved in the provision of infrastructure services as well as a range of commercial activities. Of the T$359 million infrastructure investment planned between FY2010 and FY2015, the total public enterprise investment plans make up T$170 million. 14. Deficiencies of physical transport infrastructure, principally roads and wharves, are recognized as significant constraints to business and commerce across the country. The movement of agricultural produce in particular, on which the prosperity of the outer islands largely depends, is greatly constrained by inadequacies of agricultural roads and wharves. 15. Tourist development also requires provision of physical infrastructure. The introduction of private sector competition into infrastructure provision and operation, notably in telecommunications, has met with some success. Yet key infrastructure responsibilities remain with the Government. Budget data show a long-term decline in funding for physical infrastructure and maintenance, and funding is required for a backlog of needed investment. Public enterprise legislation has been adopted to raise the performance of corporatized public providers, but its application needs strengthening.

Appendix 4 45

FISCAL ANALYSIS

A. Fiscal Performance 1. The late 1990s and early 2000s were characterized by (i) strong calls for fiscal policy to counter rising deficits; (ii) decisions to improve the strategic allocation of public resources (for example in maintaining the proportion devoted to education and health); and most significantly, (iii) pressures to respond to demands for public service wage rises. Strong restrictions on public service recruitment and allowances slowed the growth of the public wage and salary bill and the revenue performance improved. Following 4 years of growing deficits, the Government budget moved into surplus in FY2004 and remained in surplus in FY2005. 2. The public service strike and the resultant wage agreement (known as 60/70/80) then dominated FY2006. In late 2005, the Government entered into a public sector wage agreement in which it committed to implement salary increases for the public sector of between 60% and 80% by FY2007, and to undertake regular salary reviews. The Government acted quickly to fund the pay increase. Cuts were made to expenditure on goods and services, maintenance, and capital expenditure (Figure A4). A civil service restructuring and downsizing exercise also took place in the latter half of FY2006 aimed at reducing the number of civil servants by approximately 20%. 3. In total, 60/70/80 and the redundancy package created additional expenditure during FY2006–FY2007 equivalent to 15% of gross domestic product (GDP) (in each year). The additional ongoing cost is estimated to fall to 10% of GDP in FY2008 (as one-time payments are met and the number of civil servants is reduced). 4. The budget moved into deficit in FY2006, despite the expenditure cuts and sale of 20% of Westpac Bank of Tonga held by the Government. But strong revenue performance helped limit the deficit to 2.2% of GDP in FY2006, and to result in a surplus of 1.1% of GDP in FY2007 (Figure A4).

Figure A4: Budget Performance FY2006–FY2010

e = estimated, GDP = gross domestic product. Source: Government of Tonga.

Total Government Expenditure: FY2006-FY2010

0%20%40%60%80%

100%

FY2006 FY2007 FY2008 FY2009e FY2010eCurrent ExpenditureCapital ExpenditureTotal Government Expenditure

Fiscal Surplus/Deficit: FY2006-FY2010

-15

-10

-5

0

5

FY2006 FY2007 FY2008 FY2009e FY2010e

% o

f GD

P

Fiscal Surplus/Deficit

46 Appendix 4

B. The Overall Fiscal Stance

5. The Government's fiscal position improved as a result of comprehensive reforms to the tax and customs system in 2008, coupled with prudent public expenditure management over the last 4 years. This resulted in successive budget surpluses. The Expenditure Review Committee (ERC) has supported improved expenditure management through reprioritization measures when and where appropriate, thus helping to ensure a balanced budget. In 2009, the Government prepared the FY2010 budget using forward estimates as a first step to a medium-term budget framework (MTBF). Further improvements in revenue administration through the establishment of a debt recovery unit resulted in the recovery of $10 million in debt arrears and significant increases in corporate tax collections over the previous financial year. 6. The crisis impacted the fiscal position and the Government has moved to safeguard expenditures on essential services. Significant grant assistance of T$25 million from the People's Republic of China helped the Government sustain expenditures. The Government also placed a freeze on new spending within line ministries. However, the fiscal position has come under pressure from a weaker outlook for government revenue, as well as the cost of a previously agreed 10% pay increase for public servants, which will take effect in FY2010. 7. While the Government is committed to improving infrastructure, it has had difficulty funding costs from the tax revenue stream. For the most part, physical infrastructure has been established with the support of development partner financing. Deficiencies in infrastructure, particularly in the transport sector, including roads and wharves, are seen as significant constraints to medium-term growth. C. Quality of the Revenue System

8. Revenue (including grants) has been rising steadily from about 26% of GDP in FY2000 to 44% of GDP in FY2009. Progress has been made on the revenue side of the budget, with the tax and customs system modernized as part of the economic reform program. Years of ad hoc discretionary interventions created a nontransparent, confusing, and widely criticized set of tax policies in Tonga. As part of a set of comprehensive reforms in 2008, new income tax and customs legislation became effective—the income tax threshold was raised from T$2,500 to T$7,400 per annum, a tax of 10% is now levied on income earners with earnings from T$7,400 to T$30,000, and 20% for those earning T$30,000 and above. The corporate tax rate was streamlined at 25% for both residents and nonresidents with an annual turnover in excess of T$100,000. Other taxes include a 15% consumption tax on all imported and domestically produced goods and services (certain goods and services related to health and education, financial services, electricity, and public transport are exempt), and a vehicle tax. The reforms—driven by the need for Tonga to end its heavy reliance on revenue generated from customs revenue given its World Trade Organization commitments—removed the two-tier progressive company tax system and the penalty tax rate that was previously applied to foreign companies. The simplified taxation system is far less distorted and simpler to apply. 9. In FY2008, overall tax revenue as a percentage of GDP was 21.4%. In its inaugural year, consumption tax collections amounted to T$53 million, exceeding expectations by T$7 million, although an analysis of the composition of border and inland revenue collections, and information on arrears, indicate that another T$2 million–T$3 million can still be collected. Tax arrears are relatively low at T$24.6 million at the end of FY2008 (most overdue income tax). However, given the small size of the country and the lack of scale, tax administration is relatively expensive.

Appendix 4 47

10. The Revenue Services Administration Act provides the foundation for a modern system of revenue administration based on self-assessment and voluntary compliance. With consumption taxes on imported goods and import duties constituting nearly 50% of total tax revenues, a significant revenue initiative is the introduction of a computerized, internet-based customs management system, which will speed up the clearance of goods and allow more effective checking of importers’ documents and a greater focus on reducing revenue leakage through the ports. The new system will reduce the clerical inputs required for the clearance of goods, and enable importers and exporters to submit customs declarations. The reduced clerical input time for declarations will allow the reallocation of Customs Department personnel to investigate fraud, which will help improve collections. The first module of the system was launched in July 2009 and additional modules will be introduced during the first 12 months of operations, including extending the system to Vava’u, the other main port in Tonga. A tax tribunal was established to handle tax appeals and hear applications for review of decisions made by the Inland Revenue Department. In FY2009, the establishment of a debt recovery unit resulted in the collection of T$10 million in tax arrears, which was an improvement over past years. The Government is aiming to collect T$8 million in FY2010. D. Quality of Public Expenditure

11. Although overall budget control has been satisfactory, allocation and control of expenditures for individual items has been relatively weak. In FY2007, recurrent expenditures deviated from budgeted amounts by less than 10%. According to the 2007 public expenditure and financial accountability (PEFA) assessment report, from FY2004 to FY2006, total primary expenditure deviated by 2.4%, recurrent expenditure by 3.3%, and debt servicing by 13.8%. A contingency fund was established—generally set at 5% of the total budget—to cover unforeseen expenditures. The public financial management system is comprehensive in reporting; banking of all known government receipts and revenues into a consolidated fund is required. Budgetary and fiscal risk oversight is comprehensive, and public access to budget information is available once the budget is adopted. However, transparency is lacking for budget execution due to limited information available on actual government performance in implementing budgets and maintaining fiscal discipline. The total amount of arrears is less than 2% of annual outlays. 12. In FY2003, the Government adopted the IMF Government Finance Statistics framework to present budget estimates, which provides a better presentation of information on total resources allocated by the Government, and allows for regional and international comparison. This has only been partially implemented in recent budgets. The budget provides an adequate picture of general government activities. Budgeting has been greatly strengthened by the adoption of the Public Finance Management Act, 2002. The act authorizes the minister of finance to manage budget execution, enforce tighter fiscal discipline, and ensure that spending is within allocations. 13. Budget estimates are fully subject to authorization by appropriation in the legislative assembly. The Public Enterprises Act, 2002 provides a framework for monitoring the activities of government enterprises and their relationships with the budget. In November 2007, the ERC, which is chaired by the Prime Minister, was established to improve supervision of overall budgetary processes, review all expenditure requests from line ministries, and monitor budget performance. To date, links between the budget and programs intended to achieve national development goals have been relatively weak. While programs are defined, linking expenditures to programs and monitoring outcomes needs to be improved. Prioritization of budget

48 Appendix 4

expenditure is not well defined and often ad hoc. Ministries report on some indicators of achievement, but this analysis is not effectively integrated into the preparation of subsequent budgets. For example, the budget papers do not include a review of ministry performance against the indicators. The FY2009 budget, which was prepared on a cash basis, does not include any forward estimates. Tonga prepared the FY2010 budget using forward estimates as a first step to a medium-term budget framework. While not well formalized and applied yet, such a framework system will facilitate the Ministry of Finance's ability to allocate resources in a manner consistent with the priorities outlined in the new National Strategic Planning Framework, which replaced the Strategic Development Plan Eight. Budgets will be prepared on the basis of 3-year corporate plans prepared by each line ministry designed to operationalize the achievement of national development goals, which will include performance indicators to allow for progress monitoring. The Government prepared contingency plans for the potential reprioritization of and cuts in expenditure given the crisis. 14. The 2007 PEFA report indicates that the bank reconciliations were delayed, resulting in the Ministry of Finance's late issuance of financial statements. Bank reconciliation for all Treasury-managed bank accounts takes place less frequently than quarterly, or with backlogs of several months. Reconciliation and clearance of suspense accounts and advances take place either annually with more than 2 months’ delay, or less frequently. However, since 2008, bank statements are received and reconciled daily. The timeliness of current year reconciliations has been significantly improved, reducing delays from 12 months to around 1–2 months. Some concerns have been raised about the accuracy of information, but this does not fundamentally undermine its basic usefulness. The minister of finance presents a monthly fiscal update to the cabinet (introduced in 2007), including the cash position. The audit for 2008 had a 2-year delay, although the requirement is within 6 months. However, the Government has cleared the backlog of accounts up to FY2008, which are currently with the auditor general. E. The FY2010 Budget

15. The Government adopted an expansionary fiscal stance to counter the impact of the crisis. The FY2010 budget aims to support key social expenditures while maintaining macroeconomic stability. The budget forecasts a fiscal surplus (excluding the proposed program grant) of T$10.8 million, while significantly increasing expenditure. However, after projected debt repayments of T$12.4 million that will fall due during FY2010, the financing gap is T$6.6 million (about 1.0% of GDP). Importantly, although Tonga’s budget includes both in-kind and cash expenditures, the Government Finance Statistics is presented on cash basis which therefore excludes a portion of the ongoing reconstruction efforts of Nuku’alofa’s central business district and associated public works. These are being financed by a T$120 million reconstruction loan from the People’s Republic of China to the Government of Tonga. Table A4 provides an overview of key macroeconomic and fiscal aggregates over 5 years. 16. Underlying revenue declined by 10.3% in FY2009 but the Government forecast it to increase by 7.0% in FY2010 on the basis of better compliance and positive government growth forecasts. However, the most revised forecast—based on collections at the end of August 2009—projects a further decline of 18.9% reflecting weak economic conditions in Tonga’s major trading partner economies, which have impacted remittances and export demand. Tax revenue, in particular, is projected to decline by 11.4% in FY2010 (rather than the 16.7% increase in collections earlier forecast). Grants (not including the proposed Asian Development Bank [ADB]

Appendix 4 49

grant) are forecast to decline from the T$44.9 million1 budget outcome in FY2009 to T$37.9 million in FY2010.

Table A4: Summary Macroeconomic and Fiscal Aggregates

Item Unit FY2006 FY2007 FY2008 FY2009a FY2010b FY2010c Real GDP growth % per annum 0.3 (1.7) 2.7 (0.4) 1.7 0.4 Inflation % per annum 7.0 5.1 9.8 4.7 1.7 1.2 Govt. revenue Revenue % of GDP 25.2 24.8 25.2 22.6 24.2 18.3 - Tax revenue % of GDP 21.1 21.1 21.4 18.8 21.1 19.7 - Tax revenue % change per

annum 3.0 10.4 (7.5) 16.7 (11.4)

- Tax revenue T$ million 122.2 126.0 139.1 128.7 150.2 114.0 Govt. expenditure Total expenditure % of GDP 30.0 27.5 24.9 26.6 28.6 28.6 Capital expenditure % of GDP 0.8 0.9 0.5 2.5 1.7 1.7 Current expenditure % of GDP 29.2 26.4 24.4 24.1 26.9 26.9 - Personnel costs % of GDP 0.8 0.9 0.5 2.5 1.7 1.7 - Personnel costs % of current

expenditure 58.9 50.4 44.3 46.1 40.4 40.4

Budget balance Overall balance % of GDP (2.2) 1.1 1.7 1.7 (1.0) (10.3) General govt. net debt

Gross debt % of GDP 37.3 34.4 36.4 39.8 43.3 43.3 Cash and liquid assetsd

% of GDP 5.7 5.2 6.6 6.8 6.8 6.8

Net debt % of GDP 31.6 29.2 29.8 33 36.5 36.5 ( ) = negative, GDP = gross domestic product. a Estimate. b Budget. c Revised estimates for October 2009 release. d Cash and investment balance (as at 30 June for each fiscal year). Source: Government finance statistics; International Monetary Fund; Asian Development Bank. 17. Overall expenditure, which rose by 10.3% in FY2009, is projected to increase by a further 13.7% in FY2010. Expenditure on wages, salaries, and contributions will rise by 18.8%,2 other current expenditure by 26.3%, while capital expenditure from the budget (not including the reconstruction loan funds from the People’s Republic of China) will fall by 32%.3 Other current expenditure, which includes other purchases of goods and services, interest payments, and subsidies, increased by 24.6% from FY2009. The FY2010 budget provides an overall increase 3 This is the FY2009 actual amount, which reflects an extraordinary grant from the People’s Republic of China of

T$26 million, which was not included in the FY2009 budget although this amount will be disclosed in the public account for FY2009.

2 The salary and wage expenditure in the budget comprises several items that are not strictly part of the public sector wage bill, such as allowances for legislators, the privy purse, and district and town officers salaries. The salary component of the salary and wage line item in the budget estimates constitutes about 77% of the total, including employer contributions. Excluding this latter item, which is mandated in the administrative regulations to the 1998 Retirement Fund Act, the total salary and wage component of the FY2010 budget will rise by 2.2%.

3 Capital expenditure in FY2009 was distorted by the spending of about T$5 million on the purchase of a high commission in Auckland and the acquisition of land for a park in the center of Nuku'alofa.

50 Appendix 4

in the allocation to education (19%), health services (21%), and social security and welfare (42.4%). 18. Since a substantial portion of the rebuilding of Nuku'alofa and associated works is funded by the reconstruction loan,4 and because Tonga’s accounting conventions mean that this loan is not included directly in the budget, the budget estimates show a fall in capital expenditure of T$5.6 million.5 Including expenditure under the reconstruction loan, total capital expenditure amounts to T$51.8 million in FY2010 compared with T$15.2 million in FY20096—an increase of 241%. This large increase in capital spending, coupled with effective enforcement of high local content in the implementation of capital works, will promote job creation and private sector activity. 19. Following recent revisions to the FY2010 revenue forecast, the fiscal deficit is projected to be 10.3% of GDP, which represents a decline of 706% over the previous year. Net financing requirements—after accounting for debt repayments—now stands at T$42.8 million. F. Procurement

20. Based on the findings of a 2003 procurement assessment undertaken by ADB and the World Bank, and a subsequent World Bank operations procurement review, the Government developed plans to establish an effective legal and regulatory framework governing public procurement, including guidelines, manuals, and capacity development. With World Bank assistance, the Government passed the new Procurement Act, 2009; established a procurement committee; and set up a procurement section within the Ministry of Finance and National Planning. The Australian Agency for International Development and the New Zealand Agency for International Development have been supporting the Government in strengthening capacity for the implementation of the procurement system. Regulations for public procurement and the preparation of a procurement manual and standard documentation are being prepared, and procurement training of government officials delivered, with support of the Australian Agency for International Development support. G. Debt Sustainability

21. The achievement of a sustainable debt position is a key result of the economic reform. Debt distress risk remains high with total external debt averaging around 39% of GDP over the 9 years until FY2008. The Government has made efforts to reduce debt through more prudent fiscal management. Most of external debt is concessionary; however, increased borrowing from China Eximbank to fund reconstruction efforts and associated public works has increased Tonga’s vulnerability to debt distress. 22. Public external debt was the equivalent of 30.8% of GDP at the end of 2009, compared with 28.9% at the end of FY2008 and 32.6% at the end of FY2007. Significant indebtedness will be incurred from additional drawing down of the reconstruction loan over the next 2 years. The loan is on concessional terms, with a 5-year grace period and a 20-year term at 2% interest. When the drawdown is complete, the net present value of foreign debt will be approximately 36% of GDP. The debt will be 290% of net exports and tourism earnings. When remittances are included, indebtedness in terms of this measure falls to a much more manageable 135% of 4 The loan, which bears a 2% interest rate, will be repaid over 20 years with a 5-year grace period. 5 One-time items that are property purchases inflated capital spending in FY2009 by approximately T$5 million. 6 The China Eximbank loan contributed T$5.0 million to capital expenditure in FY2009. This does not appear as a

cash appropriation under capital expenditure, but is part of the net lending component of the FY2009 outcome.

Appendix 4 51

GDP. Any further borrowing on nonconcessional terms needs to be carefully and prudently considered given the current weak economic performance, and to ensure that new borrowings are used to finance projects that increase Tonga's productive capacity.

52 Appendix 5

PUBLIC ENTERPRISE SECTOR ASSESSMENT

1. The assessment draws heavily on an Asian Development Bank (ADB) comparative study of state-owned enterprises in the Fiji Islands, Samoa, and Tonga.1 Some coverage is also provided on complementary policy measures to promote private sector development and reform of the public sector. A. Public Enterprise Performance

2. Tonga’s public enterprises leave little opportunity for the private sector and depress economic growth. Public enterprises control 14%–22% of total fixed assets within the economy, yet contribute just over 6% to gross domestic product. Tonga’s public enterprises currently achieve an overall return on average equity of 3.6%, well below the 10% target return. The economic value destroyed by the public enterprise portfolio in Tonga during FY2002–FY2006 is estimated to equal around half of the government's total expenditure on health and education for the same period.

3. As of 30 June 2009, 15 public enterprises were wholly owned by the state. They are involved in the provision of infrastructure services as well as a range of commercial activities (Table A5). Of the T$359 million infrastructure investment planned over the next 5 years, the total public enterprise investment plans make up T$170 million.

4. Only the Tonga Communications Corporation has consistently met the target of 10% return on equity in recent years (Table A5). None of the other enterprises are covering their costs of capital. Preliminary indications are that in 2008, the portfolio will only return 3.6%. Improving the performance of the public enterprise portfolio requires (i) completion of ongoing effort to rationalize the remaining enterprises in the government's portfolio, which may include restructuring and divesting of activities that can be conducted more efficiently by the private sector; (ii) continued capacity development in corporate governance to strengthen directors’ ability to serve as effective stewards of their public enterprises; and (iii) an amendment to the Public Enterprise Act to place public enterprises on a firm commercial footing, imposing hard budget constraints, strengthening governance by requiring the appointment of appropriately skilled private sector directors, and stipulating that the provision of community service obligations be on commercial terms.

B. Progress in Public Enterprise Reform 5. Tonga's public enterprise reform process has been under way in earnest since 2002, when the country passed the Public Enterprises Act. Over the subsequent 5 years, with support from a series of ADB technical assistance (TA)2 projects, the Government strengthened the corporate governance of public enterprises, established a financial performance monitoring framework, trained directors and senior officials on requirements of the Public Enterprises Act, created the Ministry of Public Enterprises, developed its capacity to monitor and rationalize the public enterprise portfolio, and rationalized a number of enterprises.

1 ADB. 2009. Finding Balance: Making State-Owned Enterprises Work in Fiji, Samoa, and Tonga. Sydney and

Manila. http://www.adb.org/Documents/Studies/Finding-Balance/default.asp 2 ADB. 2003. Technical Assistance to the Kingdom of Tonga for the Rationalization of Public Enterprises. Manila (TA

4111-TON, $515,000, approved on 9 May); ADB. 2004. Technical Assistance to the Kingdom of Tonga for Public Enterprise Reform, Phase II. Manila (TA 4514-TON, $150,000, approved on 20 December); ADB. 2006. Technical Assistance to the Kingdom of Tonga for Rationalization of Public Enterprises, Phase III. Manila (TA 4899-TON, $400,000, approved on 18 December).

Appendix 5 53

Table A5: Key Performance Indicators of Public Enterprises in Tonga (T$'000, latest data as of March 2009)

Public Enterprise

Return on

Average Equity

(%) Total

Revenue

Net Profit After Tax

Total Assets

Total Liabilities

Liabilities/ Assets

(%) Tonga Communications Corporation 13.4 26,473 5,680 54,917 10,197 18.6 Tonga Broadcasting Commission 5.8 2,823 140 3,834 1,350 35.2 Waste Authoritya 13.5 1,463 591 4,962 297 6.0 Tonga Water Board (3.6) 3,822 (697) 20,280 1,156 5.7 Tonga Powerb ... ... ... ... ... ... Tonga Post b ... ... ... ... ... ... Ports Authority Tonga 3.3 6,583 462 21,964 7,504 34.1 Tonga Airports (1.3) 6,031 (611) 47,252 809 1.7 Tonga Timber 2.8 2,280 167 6,975 1,017 14.6 Tonga Print 2.2 800 29 1,549 190 12.3 Tonga Market 0.6 707 10 4,448 2,965 66.6 Tonga Investmentsc 0.3 4,834 19 6,433 1,094 17.0 Shipping Corporation of Polynesia (60.0) 3,337 (251) 2,083 2,438 117.0 Tonga Development Bank 6.2 9,283 1,517 65,240 40,351 61.8 International Dateline Hoteld (1.7) 152 (94) 8,094 2,708 33.5

( ) = negative; … = not available. a The use of accrual accounting results in overstated revenues and profits for Waste Authority Limited only 20% of

revenues accrued in FY2009 have actually been collected. b Tonga Power was repurchased by the Government in late 2008. Tonga Post was corporatized in July 2008. c Tonga Investments is in liquidation. d International Dateline Hotel is a holding company, and its results do not reflect the performance of Janfull

International Dateline Hotel, of which it is a 49% shareholder. Source: Government of Tonga. Ministry of Public Enterprise and Information.

6. The third phase of ADB support for public enterprise reform (footnote 2) focused on (i) rationalizing five public enterprises, 3 (ii) strengthening the capacity of public enterprise directors, (iii) developing capacity of the Ministry of Public Enterprise staff charged with monitoring public enterprise performance, and (iv) implementing the rationalization program. During this period, the Government resolved to remove all ministers and public servants from the boards of directors by the end of 2008. This target has not yet been fully achieved, although progress was made with five boards having only private sector directors. Further, board restructurings are planned for the 4th quarter of 2009 and mid-2010.

7. The main outcomes were the first privatization of a Tongan public enterprise with the sale in 2008 of the Government’s majority shareholding in Leiola Duty Free; the liquidation in FY2009 of Tongatapu Machinery Pool, which made its assets available to private sector contractors who were thereafter able to compete on an equal basis; and the divestiture in 2008 3 Leiola Duty Free, Tongatapu Machinery Pool, Shipping Corporation of Polynesia, Tonga Timber, and International

Dateline Hotel.

54 Appendix 5

of the Government’s minority shareholding in Westpac Bank of Tonga. In 2008, the Government purchased the assets of Shoreline Power and transferred them into a new public enterprise, Tonga Power, in anticipation of future rationalization. Strategies were prepared for the Shipping Corporation of Polynesia, Tonga Timber, and International Dateline Hotel. These strategies are currently under implementation, along with the liquidation of Tonga Investments.

8. A fourth phase of ADB support is expected to be approved in 2009. This TA, will (i) complete the rationalization of the three public enterprises carried over from the third phase;4 (ii) develop and implement rationalization plans for another eight enterprises;5 (iii) continue training for directors, managers, and Ministry of Public Enterprise staff; and (iv) prepare amendments to the Public Enterprise Act to strengthen commercial governance practices. Progress under the fourth phase rationalization program has exceeded expectations. In the first 4 months of the TA, the cabinet approved the tender for Tonga Timber, to be implemented in the 4th quarter of 2009, and rationalization strategies were developed for the Waste Authority, Tonga Water Board, and Tonga Power. Strategy development for Tonga Communications, Tonga Broadcasting, and Tonga Development Bank is ongoing. On the five restructured boards, a total of eight ministers, civil servants, and politicians have been replaced by private sector directors. Amendments to the Public Enterprise Act were prepared, and cabinet approval secured for the policy issues to be addressed by the amendment.

C. Unfinished Business 9. Upon completion of the fourth phase in July 2010, all but three public enterprises6 will have completed or be well on the way to completing their rationalization programs. Corporate governance practices will have been significantly strengthened, as will the legal basis for the commercial orientation of the public enterprises. However, public enterprise reform takes time, as individual rationalization strategies are developed, considered, endorsed by the Government, and then implemented. Therefore, the reform process will need to continue well beyond 2010, as the legal and governance reforms are phased in, and the rationalization plans fully implemented. While the reforms currently envisaged will produce many benefits in terms of reduced drain on budget resources and increased return on capital, the opportunity remains to pursue a range of public–private partnership arrangements, or full privatization of some enterprises remaining in government ownership.

D. Complementary Policies for Promotion of Private Sector Development 10. Reform of public enterprises must be accompanied by an improved environment for private sector development if the benefits of public enterprise reform are to be fully realized, and the objective of private sector-led development achieved. In 2008, ADB prepared a private sector assessment that analyzed the barriers to private sector development in Tonga.7 This showed that the productivity of both labor and capital has been low, resulting in poor returns on investment. Few new businesses have started and existing ones have been slow to expand. Job creation has been insufficient to employ the growing number of school leavers looking for work; after adjusting for inflation, wages and salaries have not risen. The main constraints to greater private sector development identified by the report are:

4 Shipping Corporation of Polynesia, Tonga Timber, and International Dateline Hotel. 5 Tonga Power, Tonga Water Board, Waste Authority, Tonga Broadcasting, Tonga Communications, Tonga

Development Bank, Tonga Airports, and Ports Authority of Tonga. 6 Tonga Post, Tonga Market, and Tonga Print. 7 ADB. 2008. Transforming Tonga: A Private Sector Assessment. Sydney/Manila. http://www.adb.org/Documents/Reports/PSA/TON/default.asp.

Appendix 5 55

(i) a perception that Tonga is a risky place to do business following the civil disturbances of 2006;

(ii) an oversized public sector lowers overall productivity both directly and by leaving little opportunity for the private sector;

(iii) infrastructure is inadequate and infrastructure services expensive; (iv) the legal framework is deficient and regulations overly complex; (v) access to finance is inadequate; (vi) incomplete and often inaccurate land records mean clearly identified and well-

protected property rights are lacking, as is a centralized, unambiguous record of who has the right to use a particular piece of land; and

(vii) agriculture sector policy is poor. 11. The Government has made significant progress in creating a better environment for the private sector. Priority areas for action include the following:

(i) Finalize the 5-year infrastructure investment plan covering both core government and public enterprise infrastructure investment.

(ii) Pass the Companies Amendment Bill. (iii) Operationalize the Companies Registry. (iv) Pass the Personal Property Securities Bill. (v) Conduct a review of license requirements under the Business License Act and

provide recommendations for their reform. (vi) Complete the review of the Foreign Investment Act and pass amendments as

required. (vii) Implement the electronic registry to support the new Personal Property Security

Act. (viii) Increase provision of microfinance. (ix) The Royal Land Commission to complete its work.

E. Required Complementary Policies: Reform of the Public Sector 12. Low productivity of the Tonga public sector is one of the causal factors of low growth. Until 2001, the public service was politicized with control highly centralized—all public sector appointments and promotions were made by the cabinet. Following the 2001 decision to reform the civil service, the Public Service Commission was established—with ADB support 8 —to oversee all aspects of public sector personnel issues. However, the intended reforms were not fully achieved. The system of wage adjustment was implemented sporadically, with large increases being followed by several years of public sector salaries being eroded by inflation. The personnel management system did not reward above-average performance, with promotions being granted on the basis of seniority rather than merit. The civil service continued to be overstaffed, employing more than 4% of the population, nearly double that of several other Pacific island countries. Despite this, service standards were often low.

13. The erosion of the real value of public sector salaries between 2000 and 2005, when no pay increases were provided, led to a public sector strike at the end of 2005. The settlement of the strike resulted in a large rise in the public sector wage bill. Following the settlement and to maintain macroeconomic stability, the Government implemented a program of voluntary redundancies, which resulted in an 18% reduction in the number of government employees. The

8 ADB. Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical

Assistance Grant to the Kingdom of Tonga for the Economic and Public Sector Reform Program. Manila (Loan 1904-TON[SF]).

56 Appendix 5

budgetary impact of the pay increase and the redundancy program was substantial. The overall wage and salary bill of the public sector, including redundancy payments, increased to more than 17% of GDP in FY2006. Redundancy payouts continued in FY2007, also affecting the wage and salary bill in that year. However, the reduction in the number of government employees meant that the ratio of wages and salaries to GDP excluding redundancy payments remained below 12% of GDP, which is not substantially out of line with public sector wage bills in other Pacific island economies. 14. The management of public service personnel policies is being overhauled. The main elements of the reform include

(i) rationalizing the number of staff at each grade and activity to flatten the structure of the public service salary grades;

(ii) eliminating automatic merit pay increases to reward above-average performers; (iii) introducing biennial public sector pay reviews to ensure that salary demand

pressures do not build up during periods when inflation is rising; (iv) streamlining personnel systems by introducing consistent rules regarding timing

of performance reviews and merit increases; (v) conducting annual performance assessments that focus on outputs to make staff

and their supervisors accountable for results; (vi) implementing major changes in leave policies, which will result in substantial

savings—by some estimates about T$8 million over 3 years; and (vii) introducing a new system for controlling public sector wages. Each ministry’s

salary and wage budget allocation will be fixed, with no overages permitted. The ministries will have the discretion to allocate salaries among its personnel, but the Public Service Commission controls the number of positions at each pay level.

Appendix 6 57

VULNERABILITY ASSESSMENT

1. The nature of poverty in Tonga relates more to lack of access to quality essential services such as water and sanitation, health and education, as well as lack of income-earning opportunities, rather than hunger or destitution. The Asian Development Bank (ADB) conducted several participatory assessments of hardship in various Pacific countries, including Tonga, during 2001–2006.1 Through this process, a definition of hardship in the Pacific was developed to include

(i) lack of access to basic services such as health care, education, and clean water; (ii) lack of opportunities to participate fully in the socioeconomic life of the

community; and (iii) lack of access to productive resources and income generation support systems

(rural credit, capital, markets, skills) to meet the basic needs of the household, and/or customary obligations to the extended family, village community and/or the church.

2. Tonga has been successful in achieving human development outcomes in terms of primary school enrollment, literacy, under-five mortality rate, and life expectancy. Tonga ranked first among the six Pacific island countries included in the United Nations Development Programme 2008 Human Development Report.2 However, challenges remain in identifying and providing adequate assistance to the most vulnerable population groups. In urban areas, access to cash income is higher than in rural areas, but access to own-produced food is lower and cash requirements for food and nonfood expenditure are higher. In rural areas, poverty is characterized more as poor access to quality essential services, including health, education, and transport. 3. In 2006, the population of Tonga was estimated to be 101,991, with almost one-quarter of the population located in the country's capital Nuku'alofa, and around one-third in the outer islands (Vava'u, Ha'apai, Eua, and Niuas), with the remainder of the population located on Tongatapu outside of the capital. 4. In Tonga, strong family and community networks provide an important informal social safety net system. Tonga has one of the highest remittance flows in the world as a percentage of gross domestic product—31% in 2008. Many families receive remittances, which mostly come from Australia, New Zealand, and the United States. Remittances provide a much-needed source of cash income, particularly for poorer households that often have few other opportunities for income generation. Church and community organizations also play a large role in providing social services such as education. However, the current economic downturn in the world economy, including the main source markets for Tonga, has resulted in decreasing remittances.3 As of June 2009, remittances were down 14% year-on-year. As a result, the existing informal social safety net system in Tonga will come under increasing stress. A. The Poverty Situation in Tonga

5. Poverty in Tonga is assessed using a national food poverty line of T$3,867 per annum, and a national basic needs poverty line of T$8,061 per annum.4 Using the headcount index as a 1 ADB. 2004. Priorities of the People: Hardship in Tonga. Manila. 2 United Nations Development Programme. 2008. The Human Development Report 2007/2008. New York. 3 ADB. 2009. Pacific Economic Monitor. Manila (August). 4 Statistics Department. 2002. Report on the Household Income and Expenditure Survey: 2001–2002. Nukualofa. A

new household income and expenditure survey was carried out in Tonga at the beginning of 2009; however, the

58 Appendix 6

measure of poverty, approximately 6.7% of the total population of Tonga is estimated to be living below the food poverty line, while 23% (almost one-quarter) is living below the basic needs poverty line. The highest share of households living below both poverty lines is in nonurban areas of Tongatapu (8.7% living below the food poverty line and 28% below the basic needs poverty line), while the lowest share of households living in poverty is located in Nuku'alofa.

Table A6: Household Income Poverty (%)

Income

Location Food

Poverty Line Basic Needs Poverty Line

Tonga 6.7 23.0 Nuku'alofa 4.1 19.1 Rest of Tongatapu 8.7 28.0 Outer Islands 7.0 22.8

Source: 2001 Household Income and Expenditure Survey. 6. According to the 2006 census, 57% of the Tongan population above the age of 15 was economically active with approximately 37% of the country's working population engaged in wage employment. In Nuku'alofa, around 80% of households receive cash income in the form of wages, which accounts for approximately 46% of total cash income. For households in the lowest income quintile, fewer households receive wage income (60%). However, for these households, wages account for a larger share of total cash income (58%). In other areas of Tongatapu and the outer islands, only between 40% and 45% of households receive wage income, with the number being significantly lower for households in the bottom quintile (18%–22%). Whereas wages account for around 50% of cash income for all households in nonurban Tongatapu and the outer islands, they account for a larger proportion of total cash income in the poorest households (around 75%). About 21% of households are engaged in subsistence agriculture in rural areas, compared with just 9% of urban households. 7. However, despite relatively high rates of labor force participation in Tonga, rising youth unemployment remains a concern. In 2003, 12% of youths (ages 15–24) were unemployed compared with the national average of 5.2%. The outer islands had the highest youth unemployment rates (18% in Niuas and 16% in 'Eua), while Tongatapu had the lowest proportion of unemployed youth (13%).5 8. Remittances provide an important source of income to the majority of households in Tonga. According to the 2001 household income and expenditure survey, 75% of all households received some remittances from overseas. In nonurban Tongatapu, 95% of households received remittances, which accounted for approximately 37% of total cash income. Among households in the bottom quintile in nonurban Tongatapu, 56% received remittances, accounting for 50% of total income. In Nuku'alofa and the outer islands, around 70% of households received remittances accounting for 26%–28% of total cash income. Although the proportion of the poorest households receiving remittances in these two regions is lower (around 56%), remittances contribute to a larger share to their total cash income (42%–44%).

data from this survey was not available at the time of preparing this assessment. As a result, data from the 2001 household income and expenditure survey is used.

5 Statistics Department. 2006 Census. Nuku'alofa.

Appendix 6 59

B. Social Protection

9. Remittances are the most important form of safety net in Tonga, providing a cushion against shocks to household income, as well as funding important living expenses including education fees, transport costs, and social obligations. Although the Government has been active in promoting universal access to health and education services as a means of promoting equality and improving living standards, it provides few other formal social safety net programs. Instead community and church organizations are very active in providing social services, particularly to vulnerable groups including people with disabilities, women suffering from domestic abuse, and children from low-income households. C. Access to Education Services

10. Tonga has achieved almost universal primary enrollment. In 2006, 98% of children ages 6–14 were enrolled in school, with little or no difference between enrollment rates for boys and girls. However, after the age of 15, enrollment falls significantly, with 15% of 16-year olds not enrolled in school (footnote 4). In 2006, the literacy rate of the 15- to 25-year-old population was 98.4% for males and 98.8% for females. However, despite the high enrollment rates, quality of education is an issue. 11. Government schools provide education to the bulk of primary students. Government schools are located on all islands, and primary education is free of charge. However, despite receiving government grants to cover some school operating budgets, communities and households are also expected to make significant financial contributions to schools. According to a participatory poverty study carried out by ADB (footnote 1), community and household contributions impose hardships for some. In addition, poorer communities have a lower ability to make contributions to schools. However, the Government recently started allocating grants to schools based on need under the Tonga Education Support Program, so that all schools are able to achieve minimum standards, which can be seen as a significant pro-poor policy. 12. Churches and nongovernment organizations provide the majority of students with secondary education, with a very limited number of places available for students at government schools. Gaining entrance to government schools is highly competitive, and the majority of students from poorer households attend church and community-run schools. Nongovernment schools also provide some education services to people living with disabilities. D. Access to Health Services

13. The underlying principles of health development in Tonga have been equity, universal accessibility, sociocultural acceptability, and affordability. As a result most health services provided by the Government are free of charge to the public, and nearly the entire population has access to medical services through the national hospital on the main island in Nuku'alofa, district hospitals in the three main island groups, and 13 health centers around the country. Despite persistent staff shortages within the Ministry of Health, Tonga has been successful in achieving good health indicators. Life expectancy is 73 years for women and 67.3 years for men. Most Tongan women (95%) give birth in the presence of skilled birth attendants. Maternal mortality is low at 36.5/100,000 live births and the infant mortality rate is 19/1000 births.6

6 Government of Tonga. Ministry of Health, 2007. Annual Health Report. Nuku’alofa.

60 Appendix 6

14. The share of government spending in the health sector has been increasing, accounting for 10%–12% of total recurrent expenditure over the past 10 years—the second largest budget allocation after education. Development partner funding also plays a large role in supporting the health sector through investments in water supply, sanitation, and hospitals. User fees are being introduced on a small scale. Overseas medical treatment accounts for about 3% of government health expenditure. 15. The incidence of noncommunicable lifestyle diseases such as diabetes and hypertension associated with obesity is increasing. For example, the current incidence of type II diabetes of 18% has nearly doubled over the past 25 years. 16. Notwithstanding generally good health indicators, rural health care services are perceived to be inadequate due to the shortages of trained staff and shortages of medical supplies. Community and nongovernment organizations are also active in the provision of health care services including family planning services, drug and alcohol counseling, services for people living with disabilities, dentistry, and care for those who suffer from domestic violence. Currently, the public sector has no services directed to the disabled or the mentally ill, or for palliative care. E. Infrastructure Services

17. Almost the entire urban population of Tonga has access to electricity, clean water, and sanitation services. However, the quality of basic services in the outer islands is generally poor. Although a majority of the population has access to clean water supplies, these are often not available 24 hours a day in many outer island communities. Also, while 80% of all households in Tongatapu have a flush toilet, this percentage is much lower in the outer islands of Ha’apai (38%) and Niuas 34% (footnote 5). 18. Deficiencies in transport infrastructure—in particular, roads and wharves—are significant constraints on the development of business and commerce. Tourist development is also constrained by the adequacy of physical infrastructure. Poor transport services to the outer islands limit income generating opportunities, particularly in the agriculture sector, due to limited access to internal and overseas markets. Poor infrastructure in the outer islands also plays a role in fuelling rural–urban migration, as the population of the outer islands moves to urban areas in search of a better quality of life. F. Conclusions

19. Hardship in Tonga is characterized by the lack of access to quality basic services and lack of cash income-earning opportunities rather than extreme poverty. This is illustrated by the fact that Tonga has the best human development indicators in the Pacific region. The Government is active in the provision of health and education services. However, nongovernment organizations and churches provide the largest range of social services to the most vulnerable segments of the population. Financial contributions from households and communities fund a large share of the operating budgets for many of these organizations. 20. Since no formal welfare system, aside from pensions, exists in Tonga, remittances provide the most important social safety nets in the country with around 75% of households receiving some cash remittances. Remittances provide an important source of income to lower-income households allowing them to pay for school fees, transport, and social obligations. However, remittances in Tonga had fallen by 14% as of June 2009 on a year-on-year basis, and

Appendix 6 61

future trends are uncertain. Although the exact impact of falling remittances on the most vulnerable groups in Tonga is not yet known, pressure is expected on the social service delivery and safety net systems. 21. The Government needs to improve its understanding of the impacts of decreasing remittances on the vulnerable and provide short-term assistance to those most affected and unable to cope. In the longer term, it needs to better identify these groups and design effective social assistance targeting systems to complement existing informal safety nets.

62 Appendix 7

STATUS OF THE RESPONSE TO THE GLOBAL ECONOMIC CRISIS 1. In its publication Taking the Helm, the Asian Development Bank (ADB) outlines a series of suggested steps for Pacific countries in dealing with the global economic crisis.1 It also outlines actions that are best avoided. This appendix provides an assessment of the Tongan Government's response to the impacts of the crisis against the "Ten Steps" or policy actions suggested in Taking the Helm. A. The Ten Steps 2. Step 1: Track and understand the impact of the global economic crisis. The main statistical collections such as gross domestic product (GDP) and other national accounts data are readily available from the Statistics Department, but these are only released on an annual basis. The Ministry of Finance and National Planning website releases semiannual economic assessment as part of the budget process and provides a useful interpretation of the statistics; a quarterly fiscal update is available locally. The National Reserve Bank of Tonga (NRBT) provides monetary data; and statistics on remittances, tourist arrivals, and tourism receipts on a timely basis. Trade data is available from the Statistics Department after a one-quarter lag. Monitoring is hindered by (i) the 12-month lag before release of national accounts; the quality of budget outturn data and absence of lead indicators; and some inconsistencies between data from the Statistics Department and the Ministry of Finance and National Planning, notably sector data. 3. Step 2: Encourage open policy dialogue. The Government has made efforts to engage the private sector in policy dialogue through the National Economic Development Council, chaired by the Prime Minister, and the regulatory reform task force, chaired by the minister of finance. The council identifies and recommends to the cabinet policy initiatives for developing the private sector, overseeing reform implementation, and reducing the cost of doing business. 4. Furthermore, as part of the new corporate planning process envisaged under the National Strategic Planning Framework, government ministries are expected to carry out their own consultations with all relevant key stakeholders. 5. Step 3: Get the monetary policy stance right. NRBT employs three main instruments of monetary management: (i) issuance of NRBT notes, (ii) credit ceilings, and (iii) reserve requirements. NRBT’s actions are guided by two primary considerations: maintaining foreign reserves at a minimum of 3 months of imports and keeping inflation below 10% per annum. 6. During the second half of 2008 and into 2009, NRBT tightened monetary policy to limit the pace of credit growth in order to limit inflation and maintain financial sector stability. Credit from the banking system to the private sector fell by 7.8% in the fiscal year ending in July 2009, while reserves recovered to 5.4 months of import cover, largely as a result of lower imports. NRBT reduced reserve asset requirements from 10% to 5% effective from August 2009 to stimulate economic activity.

1 ADB. 2009. Taking the Helm—A Policy Brief on a Response to the Global Economic Crisis. Manila.

Appendix 7 63

7. Step 4: Maintain a competitive exchange rate. Tonga maintains a broadly competitive exchange rate.The trade-weighted exchange rate appreciated by 9.4% in real effective terms in FY2009. As a result of the significant currency realignment that occurred during the second half of 2008 and early 2009, the cross rates of the pa’anga against trading partner currencies changed substantially (appreciating compared with the Australian and New Zealand dollars, and depreciating against the US dollar). However, recently the International Monetary Fund estimated that the pa'anga is overvalued by about 10%. Nevertheless, it found that the exchange rate was consistent with external stability, since the current account deficit can be financed by official and private capital inflows. 8. Step 5: “Cut and trim” low-priority government expenditure. The establishment of the Expenditure Review Committee (ERC) to review budget policy and overall resources allocation provides an important senior mechanism for identifying and trimming low priority expenditure. For the FY2010 budget, a total of T$18 million in potential budget savings was identified in response to the worsening fiscal situation. These include

(i) T$4.2 million in deferred debt repayments; (ii) T$4 million from the government's contingency fund; (iii) T$2 million from purchases of goods and services (across all ministries); and (iv) T$500,000 from travel and communication (across all ministries).

9. Step 6: Raise the revenue effort. Tonga has taken significant steps to raise revenue over the past 2 years. Extensive tax reform was implemented in 2008, which removed the two-tier progressive company tax system and the penalty tax rate that previously applied to foreign companies. The simplified taxation system is far less distorted and simpler to apply. 10. The implementation of the new Income Tax Act, 2007; Customs and Excise Management Act, 2007; Customs Act, 2007; and the Excise Tax Act, 2007 on 2 February 2008, marked the completion of Tonga's tax reform program. This program was first introduced in December 2002 with the introduction of the Revenue Services Administration Act. The first tax revenue changes were introduced in April 2005 with the introduction of a consumption tax. 11. The latest reforms, aimed at improving compliance, see a move toward self-assessment of tax returns. Online filing for tax returns is expected to be effective beginning in FY2010. The next step is web-based tax payments, but this development is dependent on the automated electronic transactions of the banking system. Discussions are continuing between NRBT and the Revenue Services Department on the possibility of extending internet banking to tax payment. This facility would improve the security of taxpayer’s payments and reduce the need for revenue services staff to be involved in handling cash. Custom administration reform of entry forms will be more efficient and accurate with the introduction of a new computerized custom management system, which went online in July 2009. Customs are also acquiring new security x-ray machines to combat smuggling and improve compliance. 12. Step 7: Protect expenditure on services for the most vulnerable. Support for the disadvantaged provided by public expenditure is difficult to assess because of a shortage of poverty analysis. Only a general tracking of expenditures is available with little use of benefit analysis and feedback of analysis of subsequent expenditure allocations. However, the Government has increased expenditure on essential social services—the FY2010 budget increases the allocation for health by 28% and for education by 5.7%—and is empowering regional and village communities by granting discretionary decision-making powers over local affairs.

64 Appendix 7

13. The Government, through the introduction of the National Strategic Planning Framework, aims to ensure all regions have the same economic and social opportunities, and contribute more to national prosperity. The framework looks to build up economic activity throughout Tonga by promoting skills, enterprise, and innovation. However, targeted regional interventions are needed to promote more balanced growth and social inclusion. The Government has set aside T$1 million for development projects in the Niuas for FY2010. 14. Step 8: Secure external financial support, where needed and affordable. Tonga has identified some external financing needed for a fiscal stimulus package that minimizes pressures on inflation and the balance of payments. It has secured grant commitments from Australia and New Zealand, and is engaging with the European Community and the World Bank Group. 15. The underlying budget deficit—around 10% of GDP—will be reduced through grants including the proposed ADB program grant. The overall cash deficit arising from the rebuilding of Nuku'alofa and associated public works is funded through external concessionary loans. 16. Step 9: Pursue quick-win structural initiatives. Tonga is undertaking an extensive structural reform program. The Government has commenced a number of important structural reform measures geared to improve productivity performance, boost the medium-term economic growth rate, and help the economy reemerge stronger from the crisis. Commercial law reform to strengthen the business environment is well advanced and requires completion. Likewise, efforts to improve access to finance through a reformed collateral framework and enhance financial services are progressing and need to be continued. The Government has also taken public service reform measures to establish the institutional framework for a more performance-oriented public service. Further work on strengthening and setting a good foundation for public financial management is undertaken in the FY2010 budget. 17. The Government has embarked on an ambitious reform program to privatize or improve performance, and reduce the drain on public sector finances. However, returns on investment are low (albeit higher than state-owned enterprise returns in the Fiji Islands and Samoa), and access to public funds provides less of an incentive to be efficient, which serves to leave little opportunity for private sector activities. 18. Step 10: Provide targeted support to the vulnerable. Limited targeted support is provided to the vulnerable. Currently, an important provision is preferential access for outer islanders to the temporary seasonal worker scheme operated by New Zealand. New programs targeting the vulnerable will take time for design and implementation. The Government has requested ADB assistance in strengthening the resilience of the vulnerable through (i) social impact analysis; (ii) identification and assessment of targeted rapid response measures such as cash for work and cash transfer programs; (iii) piloting of targeted social protection programs; (iv) support for nongovernment organization activities to protect the vulnerable; and (v) monitoring and evaluation of the impact of such activities. 19. The prospects for microfinance appear promising. A community development program is being developed for implementation in the short and medium term. B. Actions Best Avoided 20. Too large a fiscal expansion. Budgetary discipline will be controlled through careful monitoring of expenditure, including capital expenditure. The Government has tended to

Appendix 7 65

manage its fiscal accounts prudently. The response to the crisis, however, includes a modest fiscal expansion in FY2010, which represents a marked change in the fiscal stance. It will be implemented through an expansion in overall spending and a substantial increase in capital works that will be financed through grant and loan financing. 21. As set out in the forward estimates of the FY2010 budget, the fiscal expansion must be quickly restrained as economic conditions improve. 22. Excessive government pay increases. An increase in public sector wages and salaries was approved and will become effective in FY2010. The raise is associated with public service reform measures that are designed to translate into budgetary savings and productivity gains in the public service in the medium term. The wage increase was planned and negotiated as part of the public service reform process prior to the crisis. Positive compensating budgetary benefits and efficiency gains are associated with the pay award. However, pressures are likely to grow in the lead-up to the 2011 election, and restraint needs to be prudently exercised and fiscal discipline imposed. 23. Subsidies for business. The Government currently has no plans to expand subsidies to business. 24. Cuts to essential public services. The budgets for health and education have come under pressure due to the need to meet wage increase commitments made in 2005, as these ministries are the largest employers. The Government is increasing fiscal allocations in the FY2010 budget to education by 5.7%, health services by 23%, and social security and welfare by more than 42% to support the wage increases. This increase minimizes the need to reallocate from service provision to wages and salaries. The appropriate remuneration of staff is a government policy intended to support the provision of high-quality health and education services in the medium term. 25. Labor-intensive approaches to public works that are too costly. A new initiative will outsource road maintenance to the private sector, creating jobs in a cost-effective manner. This will help improve national roads, increase productivity of road maintenance expenditure, and enhance local skills. Design work is complete, with ADB support, as part of the government's larger public sector reform process, which seeks to harness the efficiency gains derived from employing private sector solutions. Road maintenance contracts, properly structured, are an ideal means of employing local labor and contracting with local suppliers. 26. Borrowing when unaffordable. The reduction in the budget deficit will be financed primarily through grants. The reconstruction of Nuku'alofa is being funded through a loan from the People’s Republic of China, signed in 2007, under concessional terms. Once the full loan drawdown has occurred, external debt will amount to slightly more than 40% of GDP, which is above the 30% threshold for external debt to GDP set by the International Monetary Fund. However, a number of mutually reinforcing efforts—including extensive structural reform measures—are under way to ensure debt returns to sustainable levels in the medium term. 27. Structural initiatives that cost jobs. No such initiatives are planned. While the public enterprise rationalization program may result in the restructuring or sale of public enterprises, every effort will be made to avoid redundancies at this stage. 28. Reform programs that lack broad support. The structural portion of the reform program has been widely consulted and publicized. Details have appeared in the local media

66 Appendix 7

and the initiatives have the strong support of the Chamber of Commerce. However, the need for reform needs to be communicated on an ongoing basis, and benefits that are expected to flow from this.

Appendix 8 67

DEVELOPMENT COORDINATION

A. Major Development Partners: Strategic Foci and Key Activities 1. The formulation and delivery of the Asian Development Bank (ADB) country partnership strategy and the program in general, and the global economic crisis response in particular, has been coordinated and aligned with other development partners, including with Australia, the People’s Republic of China, the European Commission, the International Monetary Fund (through the Pacific Financial Technical Assistance Center (PFTAC) and Article IV missions), Japan, New Zealand, and the World Bank. This process was assisted by quarterly government-coordinated and -led development partner teleconferences, which bring together resident and nonresident development partners. 2. ADB-supported analysis in the Pacific Islands Economic Report 1 and Private Sector Assessment2 has contributed to policy dialogue, clearer division of interventions, and moving to joint advocacy among the development partners. 3. These factors provide a strong basis for close coordination in response to the crisis. In addition to ADB, other development partners involved by the Government in the crisis response include Australia in the areas of infrastructure development, social sectors, and public sector reform; the People's Republic of China, the European Commission, and Japan in infrastructure development; the International Finance Corporation in private sector development; the International Monetary Fund and PFTAC in economic statistics and surveillance; New Zealand in social sectors and planned business development services; and the World Bank in transport and the education sector. Table A8 presents information of major development partners' assistance pertaining to ADB's support for the economic recovery support program.

Table A8: Major Development Partners

Sectors and Themes

Development Partner Project Name Duration Amount

Multisector (public expenditure and fiscal management)

AusAID Procurement Unit (Ministry of Finance and National Planning) Institutional Strengthening Customs, and Tax Institutional Strengthening in Procurement

2009–2010

2008–2010

…

$172,932

A$300,000

…

Multisector (economic management and public policy)

AusAID Institutional Support to Public Service Commission National Economic Development Council Institutional Support to Expenditure Review Committee, Ministry of Finance and National Planning, and proposed support to Statistics Department, and Ministry of Labor, Commerce and Industry

2008–2009

2008–2009

2008–2009

T$400,000

A$250,000

A$750,000

1 ADB. (forthcoming). Pacific Islands Economic Report – Tonga. 2 ADB. 2008. Transforming Tonga: A Private Sector Assessment. Sydney and Manila.

68 Appendix 8

Sectors and Themes

Development Partner Project Name Duration Amount

Multisector (social protection)

AusAID

Health Sector Program

2009–2012 A$7 million

Community Development Scheme

2004–2009 T$2 million per year

AusAID/NZAID

Technical, Vocational Education and Training Bi-lateral and Regional Development Scholarships

2009–2013

annually

A$7 million

T$8million per year

NZAID/WB

Education Support Program

2005–2010 NZ$14 million $1 million

NZAID Assistance to Tongan NGOs (National Centre for Women and Children, Civil Society Forum of Tonga) Outer Island Community Development Medical Treatment Scheme Niuatoputapu High School

annually

2009–2010

annually

2008–2009

T$300,000

NZ$350,000

NZ$400,000

T$3.2 million

PRC Community Health Centers Vava’u Hospital Extension

2009–2010

…

T$4.7 million

…

Japan Medical Equipment and Supplies Grassroots Program Technical Cooperation in Primary Education, Vocational Training, and Health Sector

2006

annually

…

$1 million

T$1.6 million

…

UNDP Millennium Development Goals Budgeting

2009–2010 $225,000

Economic growth AusAID/NZAID Private Sector Recovery Facility Tonga Police Development Program (infrastructure component)

…

2008–2012

…

T$5 million

World Bank/AusAID

Transport Sector Program including Road Maintenance

2008–2011 $5.44 million

Japan Upgrading of Vailoa Hospital (phase II)

… …

Private sector development

NZAID Business Enterprise Centre Tourism Support Program

…

2009–2010

…

NZ$1 million

IFC Companies Registry, Business Licensing Reform, Foreign Investment Framework

2008–2009 T$300,000

… = not available, ADB = Asian Development Bank, AusAID = Australian Agency for International Development, IFC = International Finance Corporation, na = not available, NGO = non-government organization, NZAID = New Zealand Agency for International Development, NZ$ = New Zealand dollar, PRC = People’s Republic of China, UNDP = United Nations Development Programme. Source: Government of Tonga and Asian Development Bank.

Appendix 8 69

4. In terms of the proposed program, close coordination was undertaken especially in the areas of public financial management with Australia (which features high in the Tonga–Australia Partnership for Development Agreement);3 and the International Monetary Fund and PFTAC in the course of the Article IV surveillance mission and analytical work on economic and fiscal policies. B. Institutional Arrangements and Processes for Development Coordination 5. Aid coordination is the responsibility of the Aid Management Division in the Ministry of Finance and National Planning. The institutional location of this unit acts to create strong links between development partner activities and the national development plan (now the National Strategic Planning Framework) and the annual budget. In addition to the quarterly development partner teleconferences, the Government holds annual development partner forums in Nuku'alofa, Tonga. These typically include discussions on aid harmonization, programming, and policy issues. The forum provide an opportunity for the Government to present its development plans and priorities, update progress in implementation of existing priorities, and seek development partner support for new initiatives. 6. To ensure effective coordination of support from ADB, Australian Agency for International Development, and New Zealand Agency for International Development, a Declaration between the Government of Tonga and Development Partners was formulated in conjunction with the Government during 2007 and jointly signed during the Pacific Islands Forum leaders meeting in Tonga in late 2007. The declaration is guided by the principles of the Paris Declaration on Aid Effectiveness, and sets out areas of joint agreement on a process of effective coordination in development cooperation work in Tonga. The declaration incorporates an action plan that defines concrete coordinated actions by the Government and development partners to improve aid effectiveness. 7. The ADB–World Bank Tonga country focal officer (funded by ADB under a regional TA),4 joint ADB–World Bank Country Focal Office, provides an immediate point of contact for both Government and other development partners in Tonga and as such greatly facilitates strengthened development coordination. C. Achievements and Issues 8. Of the several broad achievements in aid coordination in Tonga, the highlights are the signing of the Declaration between the Government of Tonga and Development Partners and the regularity of government-led development partner meetings. 9. More specifically, preparation of the program was undertaken in close consultation with the Australian Agency for International Development and the New Zealand Agency for International Development within the country and at headquarters. Similarly the People’s Republic of China and Japan International Cooperation Agency were consulted and kept informed of national program development. Broader regional dialogue on appropriate responses to the crisis, which included the Australian Agency for International Development, the European Union, the International Monetary Fund and PFTAC, the New Zealand Agency for International Development, and the World Bank, was used to consult and keep partners informed of the preparation of the Tonga program. 3 In particular, the program's policy matrix in the area of public financial management is aligned with the Tonga–

Australia Partnership for Development to facilitate coordinated or joint dialogue and monitoring in this area. 4 ADB. 2009. Technical Assistance for Enhancing Engagement with Pacific Developing Member Countries (TA

6475-REG). Manila.

70 Appendix 8

10. Program preparation was backed by ADB's timely and focused analytical work which was shared widely with the development partners and reviewed by an eminent panel of experts, including some development partner representatives. D. Recommendations 11. The program includes a public communications element that is intended to build awareness, understanding, and ownership of the economic recovery support program within Tonga. Ensuring the timely development and implementation of this component will act to strengthen aid coordination. 12. The opportunity of development partner meetings should be used to regularly and formally update development partners of program implementation progress.

Appendix 9

71

LIST OF INELIGIBLE ITEMS

No withdrawals will be made for the following:

(i) Expenditures for goods included in the following groups or subgroups of the United Nations Standard International Trade Classification, Revision 3 (SITC, Rev. 3) or any successor groups or subgroups under future revisions to the SITC, as designated by ADB by notice to the Recipient:

Table A9: Ineligible Items

Chapter Heading Description of Items 112 Alcoholic beverages 121 Tobacco, unmanufactured; tobacco refuse 122 Tobacco, manufactured (whether or not containing tobacco

substitute 525 Radioactive and associated materials 667 Pearls, precious and semiprecious stones, unworked or worked 718 718.7 Nuclear reactors, and parts thereof, fuel elements (cartridges),

non-irradiated for nuclear reactors 728 728.43 Tobacco processing machinery 897 897.3 Jewelry of gold, silver or platinum-group metals (except watches

and watch cases) and goldsmiths’ or silversmiths’ wares (including set gems)

971 Gold, nonmonetary (excluding gold ore and concentrates) Source: United Nations. (ii) Expenditures for goods supplied under a contract that any national or international

financing institution or agency will have financed or has agreed to finance, including any contract financed under any loan or grant from the ADB;

(iii) Expenditures for goods intended for a military or paramilitary purpose or for luxury consumption;

(iv) Expenditures for narcotics;

(v) Expenditures for environmentally hazardous goods, the manufacture, use or import of which is prohibited under the laws of the Recipient or international agreements to which the Recipient is a party; and

(vi) Expenditures on account of any payment prohibited by the Recipient in compliance with a decision of the United Nations Security Council taken under Chapter VII of the Charter of the United Nations.

Appendix 10

72

SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY

Country and Project Title: Tonga: Economic Support Program Lending/Financing Modality: Program grant Department/

Division: Pacific Department South Pacific Subregional Office

I. POVERTY ANALYSIS AND STRATEGY

A. Link to the National Poverty Reduction Strategy and Country Partnership Strategy The Tongan economy is relatively undiversified, which makes it vulnerable to the global economic crisis. The heavy reliance on remittances and tourism reduces the short-term prospects for robust economic growth. The response to the impact of the crisis requires extraordinary measures by the government, chiefly in fiscal policy and management, supported by fiscal, social, and, to some extent, monetary policy. In April 2009, the cabinet approved a fiscal stimulus approach, primarily through accelerating investment in infrastructure to help offset the adverse effects of the crisis. The crisis response is in line with the new National Strategic Planning Framework, which aims at sustained equitable economic growth in Tonga by focusing on a number of outcomes that are directly linked to the proposed program, including the priority areas of (i) community development, (ii) private sector growth, and (iii) improved provision and maintenance of infrastructure; as well as the enabling themes for the public sector: (i) making government smaller and more efficient, (ii) strengthening public enterprise governance and performance, and (iii) improving the effectiveness of revenue collection. The proposed program is consistent with ADB’s 2007–2012 country partnership strategy for Tonga, ADB’s Pacific Strategy, ADB's Strategy 2020a, and ADB's current efforts to assist developing member countries address the impact of the crisis. B. Poverty Analysis Targeting Classification: General intervention 1. Key Issues While recent hard data on poverty and hardship is not currently available (a new household income and expenditure survey is under way), the subdued economic conditions, combined with the significant decline in remittances, will likely translate into higher unemployment and increased hardship for the poor and vulnerable. The lack of formal social protection systems will compound the impacts on the poor and vulnerable, although subsistence farming offers some relief. Weak revenue performance could also place significant pressure on government expenditure programs. This in turn has the potential to add to pressure on the most vulnerable members of the community arising from an easing in labor demand and the high cost of living. In-depth analysis of the social impacts of the crisis is needed, with a view to designing, piloting, and implementing appropriate social protection measures. Although Tonga’s social indicators are the best in the Pacific region, about 25% of the population has incomes that are below the basic needs poverty line. The Government is reforming service delivery to better meet the needs of the population through improved governance and service delivery of public enterprises and more explicit accounting of community service obligation. While these measures should improve basic services in roads, wharfs, electricity, water provision, and interisland transport, the impact on the poorer members of the community will need to be monitored. The Government is also increasing fiscal allocations on education and health spending through the provision of more teachers and health professionals. Policy reforms that result in higher sustainable long-term growth will have a positive impact on poverty reduction. However, ongoing poverty monitoring through surveys and data gathering will be needed to ensure that these measures are benefiting the poor. Feedback from this analysis will allow necessary changes in the design of community service obligations and ensure better targeting of safety nets to provide access for the poorest Tongans to improved basic services. 2. Design Features The program will provide fiscal resources to the Government to respond to the crisis by supporting structural reform for medium-term growth in competitiveness, and protecting the vulnerable through enabling social expenditures. In terms of social protection, the Government has undertaken to at least maintain the core expenditure in social sectors to protect those most vulnerable to the impacts of the crisis. In particular, the Government is committed to maintain core social expenditure in the health and education sectors during FY2010–FY2011, including expenditure for nurses, rural clinics, and primary education, as in FY2009. The Government will commission an expenditure tracking system for health and education. The Government will also introduce and implement a new community development program, empowering district and town offices to implement programs to boost youth and female employment while improving public services. The Government will maintain if not increase its expenditure in relation to strengthening community development and related budget allocations in the FY2010 and FY2011 budgets. To enhance financial inclusion, especially in remote areas, the Tonga Development Bank is assessing options for providing rural and

Appendix 10 73

microfinance products and services. In addition, the program provides an anchor for a proposed regional project, for financing by the Japan Fund for Poverty Reduction (JFPR), designed to strengthen the resilience of the vulnerable through social impact analysis, identify and assess targeted rapid response measures such as cash for work and cash transfer programs, pilot targeted social protection programs, support nongovernment organizations’ activities to protect the vulnerable, and monitor and evaluate the impact of such activities.

II. SOCIAL ANALYSIS AND STRATEGY

A. Findings of Social Analysis Key Issues. The impact of the program on increased social service budget allocations as well as better service delivery should provide benefits to the Tongan economy and the Tongan people. The reform program will raise the sustainable growth rate of the Tongan economy in a way that will help those at the lower end of the income scale. It will help finance the protection of critical core social expenditure. No negative social impacts are expected.

B. Consultation and Participation

1. Provide a summary of the consultation and participation process during the project preparation. Consultations on the proposed program, and in particular the associated reform components especially in public enterprise and structural reform, were carried out with key stakeholders including Government, private sector organizations, and the development community. Comprehensive consultations were undertaken in relation to the structural reform component. In particular, ADB’s 2008 private sector assessment for Tonga was widely consulted, prepared in cooperation with the Tongan Chamber of Commerce, publicly launched by the Prime Minister, and published under ADB’s private sector assessment series. Various stakeholder consultations were held and strong engagement established with public enterprises during the course of successive technical assistance projects promoting the reform of public enterprises. Stakeholder consultations, both publicly and in smaller target groups, have been held on the reform of the legal business environment and the personal property securities reform. 2. What level of consultation and participation (C&P) is envisaged during the project implementation and monitoring?

Information sharing Consultation Collaborative decision making Empowerment 3. Was a C&P plan prepared? Yes No

Consultations during program implementation will be ongoing, particularly under the various program components.

C. Gender and Development 1. Key Issues. While hard data is not available, some evidence indicates that women are particularly exposed to the impact of the crisis, as they are often overrepresented in lower-paid jobs in most sectors of the economy, in particular handicraft production, which forms the basis for a significant part of the remittance flows. In addition, women suffering from domestic abuse make up one of the most vulnerable sections of the population.

2. Key Actions. Measures included in the design to promote gender equality and women’s empowerment—access to and use of relevant services, resources, assets, or opportunities and participation in decision-making process:

Gender plan Other actions/measures No action/measure

The program will include a social impact analysis and promote the design of social protection measures and pilot programs. Given the high exposure to vulnerability for women in relation to the economic crisis, the analysis and ensuing programs are expected to benefit women. The social protection measures undertaken as part of the program will have a positive impact on women as they will benefit from protected social government expenditure, and community development programs that will help boost youth and female employment. The legal reform components of the structural reform package should improve women’s access to commercial activities by simplifying procedures for women’s groups to incorporate companies. The amendments to the Companies Act will allow women to incorporate companies quickly and inexpensively without the need for expensive legal advice. The simple procedures provided under the amendment will allow women to file returns and an expensive company secretary will no longer be needed as this office is removed under the amendment. The current high transaction costs, which are having a negative effect on the incorporation of companies by women, will be reduced significantly as soon as the new act is passed and the registry is operating. A component of the planned

Appendix 10

74

implementation program will be targeted to women’s businesses and women’s community groups. This will include developing materials, training women, and developing advisory capacity within the registry to assist women who wish to form and operate companies in Tonga. In addition, the proposed secured transactions bill will provide women with greater opportunity to borrow against a range of personal assets, which currently is either not possible legally or prohibitive because of transaction costs. This may include shop inventory, handicraft goods, and tapa cloth.

III. SOCIAL SAFEGUARD ISSUES AND OTHER SOCIAL RISKS

Issue Significant/Limited/ No Impact

Strategy to Address Issue Plan or Other Measures Included in

Design Involuntary Resettlement

No impact

The program is not envisioned to require any resettlement.

Full Plan Short Plan Resettlement

Framework No Action

Indigenous Peoples

No impact

The program is not envisaged to have any specific impacts on indigenous people.

Plan Other Action Indigenous Peoples

Framework No Action

Labor

Employment opportunities

Labor retrenchment Core labor standards

Significant

In the medium term, additional private sector job opportunities should be created as the contracting out program is extended and additional infrastructure projects are initiated. In the longer term, a more effective and more efficient public service, improved access to finance, more efficient public enterprises, and a reformed commercial legal framework should raise productivity, reduce the costs of doing business, and promote private sector development, hence, create private sector job opportunities.

Plan Other Action No Action

Affordability

No impact

No measures required.

Action No Action

Other Risks and/or Vulnerabilities

HIV/AIDS Human trafficking Others(conflict, political

instability, etc), please specify

No impact No other social risks of the program have been identified.

Plan Other Action No Action

IV. MONITORING AND EVALUATION

Are social indicators included in the design and monitoring framework to facilitate monitoring of social development activities and/or social impacts during project implementation? Yes No a ADB. 2007. Country Partnership Strategy: 2007–2012 for Tonga, Manila; ADB 2008. Working in Fragile

Environments: A Midterm Review of the Pacific Strategy (2005–2009). Manila; ADB. 2008. Strategy 2020: The Long-Term Strategic Framework of the Asian Development Bank, 2008–2020. Manila.