Tonga: Technical Assistance Report-Modernizing the Monetary Policy Framework and Operations of the NRBT

The IMF conducted a Technical Assistance mission to assist the National Reserve Bank of Tonga (NRBT) in modernizing its monetary policy framework. The mission aimed to address persistent challenges such as excess liquidity and an inactive interbank market, which have impeded effective monetary policy transmission. The mission is significant as it builds on previous IMF assistance and addresses key vulnerabilities in Tonga's monetary policy framework. The mission also aligns with ongoing Fund surveillance and program priorities. The mission found that the effectiveness of Tonga's monetary policy framework is constrained by gaps in both the institutional arrangements and the calibration of NRBT’s monetary policy actions. In this context, the mission focused on developing a modernized market-based monetary operational framework that enables active liquidity management and the alignment of short-term money market rates with the NRBT policy rate. The mission also focused on improving collateral policies (for liquidity providing monetary policy operations) and strengthening NRBT communications as key complementary tools. To this end, innovative tools were applied, such as Large Language models to assess NRBT communications, and the provision of collateral haircut methodologies to improve risk management. The mission recommended a gradual modernization process focusing on two main workstreams: developing the NRBT’s analytical capacity to assess the monetary policy stance and enhancing its operational capacity to align money market rates with the desired policy stance. This involves transitioning to a mid-rate interest rate corridor with regular open market operations supported by adequate standing facilities, and a robust liquidity monitoring and forecasting framework.