Tonga Private Sector Assessment Update, 2012

8/10/2019 Tonga Private Sector Assessment Update, 2012

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CONTINUING REFORMTO PROMOTE GROWTHUpdate of the Private Sector Assessment for

TONGA


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CONTINUING REFORMTO PROMOTE GROWTH

Update of the Private Sector Assessment for

TONGA


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Contents

Boxes, Figures, and Tables iv

Foreword v

Abbreviations vi

Currencies vii

Executive Summary viii

Diagrammatic Summary x

Introduction 1

Context 2

Tonga, the Global Economic Crisis, and Public Sector Finances 2Impact of the Global Economic Crisis on the Private Sector 4Policy Continuity 5Recent Reforms to Promote Private Sector Development 6

Reducing Constraints to Private Sector Development and Reform Progress in Tonga 8

Recovery from the Shock of the Civil Disturbances 8The Rebuilding of Nukualofa 8Related Issues 9

Reducing the Presence of the State in the Economy 9State-Owned Enterprises Are a Drag on Growth 10State-Owned Enterprises Crowd Out the Private Sector 12State-Owned Enterprises Provide Costly and Inefficient Infrastructure Services 12Details of the State-Owned Enterprise Reform Measures 13Downsizing the Civil Service 15

Improving Infrastructure 17Roads 17Shipping and Air Transportation 17Telecommunications 18

Modernizing and Rationalizing Commercial Laws 19The Companies Act and Registry 19Filling the Gaps in the Commercial Legal Framework 19


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C O N T E N T S

iv

Removing the Barriers Created by the Present Business Licensing Regime 21Increasing Access to Finance 24

The Personal Property Securities Act 25Credit Bureau 25

Supporting Agriculture, Fishing, and Tourism 26

Agriculture and Fishing 26Promoting Tourism 28

Institutions to Support Private Sector Growth 29

Recommendations for Further Reform 31

Appendix: Summary of 2008 Private Sector Assessment Recommendationsand Progress to Date 33

Bibliography 36

Boxes, Figures, and Table

Boxes1 Higher Taxes, Lower Revenue 52 Privatization 113 Business Licensing Problems 204 Visa Requirements for Foreign Investors 215 Business Licensing Risks 23

Figures1 Real Per Capita Gross Domestic Product and Growth 22 Tongas Tourism Arrivals 33 Relative Commercial Electricity Costs in the Pacific 134 Public Sector Wage and Salary Bill 165 Ratio of Private Sector Credit to Gross Domestic Product 24

Table 1 Economic Impact Indicators for State-Owned Enterprises in Tonga 10


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Foreword

In 2008, the Asian Development Bank (ADB) published Transforming Tonga: A Private Sector Assessment (PSA), which found that Tonga had registered negative productivity growth foran extended period. Following discussions between ADB and the government on the PSArecommendations, Tonga embarked on a far-reaching private sector-oriented reform program. Itaimed at improving the Tongan business environment to encouraging private sector investmentand entrepreneurship. In the area of business law reform, a comprehensive amendment to theCompanies Act was passed in 2009, and an electronic registry is being installed, which willreduce the cost of starting businesses. In 2010, a Personal Property Securities Act was passed,and a supporting electronic registry was established, which will increase access to credit. Thegovernment also embarked on a program to improve the efficiency of Tongas state-ownedenterprises. Although the reform agenda is incomplete, particularly in the area of businesslicensing, the reforms that were implemented should bring significant long-term benefits tothe Tongan economy. ADB has supported the implementation of many of these measures.

Although the global economic crisis hit the Tongan economy particularly hard, revisedstatistical data show that the economy expanded over the past 3 years. Worker remittances,which were the equivalent of 31% of gross domestic product in 2008, dropped to 20% in2009. Since remittances generate a significant proportion of income used for consumptionin Tonga, the decline had a negative impact on domestic demand and government revenue.

While the government states that private sector-led growth is a key component of itseconomic strategy, a number of its policies have negatively impacted businesses in Tonga. Inparticular, government efforts to raise revenue and improve cash flow by increasing licensefees and delaying business tax reimbursements at a time when business conditions weredeteriorating have had a severe negative impact on investment and domestic demand moregenerally. However, discussion with government on an earlier draft of this report resulted ina far-reaching review of the licensing system with the assistance of the ADB.

This PSA update, prepared in close consultation with representatives of the Tongangovernment and private sector, is part of the regular update of analytical work under thePacific Private Sector Development Initiative. It shows that the private sector still facessignificant challenges that need to be overcome for the economy to fulfill its long-termgrowth potential. The decision to undertake a thorough review of the business licensingprocess is especially welcome.

While the PSA suggests that much remains to be done, the analysis and recommendationscontained in this report will help address constraints to private sector growth and development,and improve economic outcomes.

I trust that this PSA will engage policy makers and encourage them to make further progresson necessary reforms.

Xianbin YaoDirector GeneralPacific Department


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vi

Abbreviations

ADB Asian Development Bank AusAID Australian Agency for International DevelopmentCBD central business districtCEDC Cabinet Economic Development CommitteeGDP gross domestic productIFC International Finance CorporationIMF International Monetary FundkWh kilowatt-hourm2 square meterMAFFF Ministry of Agriculture, Food, Forestry and FisheriesNEDC National Economic Development CouncilPRC Peoples Republic of ChinaPSA private sector assessmentPSDI Pacific Private Sector Development InitiativeROE return on equitySOE state-owned enterpriseTCC Tonga Communications CorporationTERM Tongan Energy Road MapTEQ-M Tonga Export Quality Management


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Currencies

A$ Australian dollar

CNY Chinese yuan

T$ Tongan paanga

$ United States dollar

NOTE REGARDING TONGAS FISCAL YEAR

The fiscal year (FY) of the Government of Tonga ends on 30 June. FY before a calendar yeardenotes the year in which the fiscal year ends, e.g., FY2008 ends on 30 June 2008.


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viii

Executive Summary

Since 2007, Tonga has undertaken a number of wide ranging private sector-oriented reforms,which will assist in raising productivity and economic growth in the long-run. However, acombination of the impact of the global economic crisis and remaining constraints to privatesector development has resulted in a significant erosion of business confidence.

The global economic crisis, and in particular the very substantial decline in remittances, hasresulted in an estimated reduction of gross domestic product of 3 percentage points over theFY2009FY2011. As a result, domestic demand has fallen sharply and government revenueshave further declined.

The private sector acknowledges the positive impact of reform. However, low local spendingand a reduction in government contracts have led to a substantial decline in demand forTongan products, while cash flows have been put under significant strain by delays in taxrefunds and more vigorous and costly enforcement of business licensing requirements.

Business licensing is imposing a combination of costs and uncertainty, particularly for foreigninvestors, which has had a damaging effect on investment. Until risks and costs of investmentare reduced, the recovery of the economy will be slow and it will be difficult to raise thelong-term growth rate.

Infrastructure services are expensive partly because of the high cost of power, which in turnarises from the high cost of fuel landed in Tonga. Although renewable energy investment isunderway, this will only reduce the cost of power in the medium- to long-term.

The reform recommendations are:

Reform the license and permit processes involved in establishing and runningbusinesses, both for Tongans and for foreigners. This involves repealing orstreamlining several processes, namely:

Repealing the Business Licenses Act 2002 1 and replacing it with legislation andprocesses that provide for licensing businesses rather than activities, includingabolishing sector licensing except for health and liquor licenses; and

Modernizing and simplifying the requirements for obtaining a business visa.

Restructure revenue collection and processing to speed up tax refunds, initially byallowing offsets of taxes owed by businesses against refunds owed to businessesby government;

1 Editors Note: Subsequent to the Private Sector Development Initiative (PSDI) support in drafting the BusinessLicense (Amendment) Bill, the Tongan Parliament passed the Bill in October 2012 although, at the time of print-ing, the new Act had yet to be released for review.


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Enact key business laws on bankruptcy, contracting, trusts, electronic transactions,and arbitration to fill in the gaps in the commercial legal framework. Complete thetransition to a fully electronic company registry and amend the Companies Act toprovide for community companies;

Although a preliminary financial analysis indicated the viability of establishing afuel tank farm as a possible way to bring down the cost of electricity, a decision toproceed with the proposal should be based on a comprehensive evaluation, whichconsiders the issue from all aspects including finance and the environment;

Continue with the commercialization and privatization of state-owned enterprises(SOEs) and develop shared services to counteract the lack of capacity and capabilities;

Prohibit ministries from undertaking commercial activities unless there is a clearneed that is not already met by the private sector;

Reduce the public sectors wage and salary bill, as a share of total public expenditure,in line with the fiscal responsibility ratios;

Reform the Ministry of Agriculture and Food, Forests and Fisheries to make it client-friendly. Commercialize and privatize the chemical biosecurity facilities and contractout the agricultural extension services;

Upgrade infrastructure through greater use of contracting out; Seek to develop a credit bureau at the earliest opportunity; and Use the National Growth Committee as a vehicle for meaningful engagement

between the government and private sector, and use this as a joint governmentand private sector task force to improve international airlines and shipping services.It is essential that government representation on the committee be at the highestlevels to ensure that its deliberations feed into policy discussions more generally.


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Introduction

This analysis is a follow-up to Transforming Tonga: A Private Sector Assessment .2 It assessesprogress made until early 2012 in reducing transaction costs and other barriers to growth asidentified in the 2008 private sector assessment (PSA). It concludes that Tonga has been oneof the leading reformers in the Pacific in improving its business environment. Unfortunately,the combination of adverse macroeconomic shocks arising from the 2008 global economiccrisis, poor fiscal planning, and the overly zealous application of the business licensing system,has resulted in many private sector businesses being severely challenged to the extent thattheir very survival is in question.

The analysis commences with a brief overview of the impact of the global economic crisis onthe Tongan economy. This is followed by a recap of the findings of the earlier PSA and thegovernment reform responses in the 3 years since it was published. The remaining constraintsto private sector growth are then described. The analysis concludes with further reformrecommendations.

For the 2008 PSA, numerous business people and senior government officials were interviewedto solicit their views on issues that impact the private sector. For this follow-up review, many ofthe same people were contacted to obtain feedback on progress to date and the state of playfor the private sector. Overwhelmingly, they pointed to the damaging impact of the globaleconomic crisis on business conditions and on Tongas economy. In particular, remittances,which at one point were the equivalent of over 30% of gross domestic product (GDP),declined sharply. This appears to have had a powerful negative impact on consumption.As a result, businesses in Tonga have suffered from substantial declines in the demand fortheir products and services. Under such circumstances, the only available policy optionsinvolve minimizing the damage from events that are beyond the control of policy makersin small open economies, such as Tonga. To some extent this has been donealthough, assubsequent discussion will reveal, some measures remain to be implemented.

Even though some major reforms have occurred in the areas of commercial law reform,secured transactions reform, and state-owned enterprise (SOE) reform, there has been limitedprogress, or even retrogression on a number of key issues identified in the 2008 PSA thatunderlie the low productivity that has dogged Tonga for many years. Since the long-termprosperity of Tonga is highly dependent on productivity improvements, efficiency increases inthe Tongan economy will determine future growth rates. These issues are discussed in moredepth in the sections that follow.

2 Asian Development Bank. 2008. Transforming Tonga: A Private Sector Assessment . Manila.


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2

Context

Tonga, the Global Economic Crisis, and Public Sector Finances

Figure 1 Real Gross Domestic Product Growth10

9

8

7

6

5

4

3

2

1

-1

-2

-3

-4

FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011

Source: Government of Tonga, Statistics Department. National Accounts Statistics 2012.

Tongas economy was badly affected by the twin shocks of the civil service strike and the civildisturbances in 2005 and 2006, which resulted in gross domestic product (GDP) declining in2 successive financial years. Subsequently, growth resumed (Figure 1). Recently revised GDPdata indicate that the economy expanded in the 4 years to FY2011, in spite of the negativeimpact of the 25% fall in remittances on consumption expenditure. 3 While inflows have

3

Remittances are an important source of income for many

Tongan families. As a percentage of GDP (national incomedata are not available) remittance flows to Tonga are among the highest in the world. Remittance inflows peakedat T$213 million in the year to February 2008. (National Reserve Bank of Tonga). They appear to have bottomedout at T$153 million in the year to March 2010, a 28% decline. Remittance flows appear to be highly dependenton economic conditions in the sending country. Since nearly 50% of remittances originate in the United States, theslow recovery of the US economy has had a long-term impact on remittance flows. The International Monetary Fund(IMF) estimates that during FY2011, remittances dropped by 9.25 percentage of GDP compared with FY2008.

%


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recovered slightly, the continued weakness in the economies from which most remittancesemanate make it unlikely that they will return to previous levels.

Tourism receipts also declined in 2006 during the first impact of the crisis. They subsequentlyrecovered as tourist arrivals increased initially helped by the political uncertainty in Fiji.However, by 2011, tourist arrivals had fallen back to the levels of 2006.

Interviews with government, banks, and the private sector indicate that the global economiccrisis caused a decline in private sector investment, which has continued into 2012. Theimpact on the private sector has been substantial. However, the rebuilding program in thecenter of Nukualofa provided a countercyclical influence and is probably the main reasonwhy the economy registered positive growth over the past 4 years.

The private sector was also impacted by the commercial banks consolidation of their balancesheets, in response to the doubtful debts that arose from the lax lending practices in theperiod to 2008. As a result, private sector credit has contracted for nearly 3 years.

A contributing factor to the decline in government revenue receipts arose from the incompleteimplementation of revenue reform. Total current revenue declined from T$162.5million inFY2008 to T$132.2million in FY2011. Over the same period, the public sector wage billrose from T$74.6 million to a projected T$91.5 million, an increase of 23%. As a result, thepublic sector wage bill rose from 46% of current expenditure in FY2008 to 61% in FY2011.In mid-2011, the government announced that planned cuts in the number of public sectoremployees had been postponed even though the Minister for Finance and National Planning,when introducing the FY2012 budget, announced that a deficit was being funded through

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Source: National Reserve Bank of Tonga. 2011. Quarterly Bulletin. December. 22 (4). Nukualofa.


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4

C O N T I N U I N G R E F O R M T O P R O M O T E G R O W T H

donor support. 4 There is also currently a provision for automatic public sector salary increaseseach year.

Tonga is a small, remote economy and, over the long term, its prosperity crucially dependson its ability to connect with the outside world. Telecommunications and maritime andair transport facilities are the channels through which these connections occur. The global

economic crisis has negatively impacted the capacity and frequency of both shipping andaircraft services to the country. When Tonga and Samoa stopped providing flight subsidies in2010, Air New Zealand withdrew the weekly Boeing 767 service from Auckland to Los Angeles,which had landed in both countries. Shipping lines have also reduced the frequency of servicesin response to increased costs and reduced volumes. Connectivity through telephone serviceshas, however, increased, and international call costs have continued to decline as a result ofcompetition. The project 5 to connect Tonga to the western arm of the Southern Cross fiberoptic submarine cable will greatly improve internet speed and capacity while reducing costs.This development could open up new business opportunities, such as the development ofinternational call centers, and support growth in tourism and the private sector in general(see Figure 2: Tongas Tourism Arrivals).

Impact of the Global Economic Crisis on the Private Sector

Following civil service strikes in 2007, there was a sudden and substantial increase in publicsector wages (50%), as documented in the 2008 PSA. The 2008 global economic crisishas subsequently resulted in a continuing rise in public sector wages and salaries in totalgovernment expenditure, with further increases expected. To contain the public deficit, thegovernment has sharply cut other government expenditure items, including purchases fromthe private sector.

The tax authorities have also been searching for additional sources of revenue and cashflow savings. Two particular measures have had a powerful adverse effect on the privatesector. There has been substantial pressure on business cash flows from delays in refundsof the consumption tax, which in some cases are more than 12 months in arrears. Refusalby the tax authorities to allow offsets, where taxes owed can be set off against refunds thathave not been paid, has compounded the impact. Businesses have been prosecuted for thenonpayment of consumption taxes, even though they were owed hundreds of thousandsof paanga in tax refunds. 6 Good tax policy allows for offsets unless there is strong evidencethat there is a legitimate dispute regarding refunds.

4 Australia, New Zealand, and the World Bank are providing budget support in 2012 around a common matrix.This includes the following public sector reform: (i) impose a hiring freeze prior to the implementation of therestructure and ensure maintenance of centralized control over any hiring during the restructure process;(ii) ensure effective implementation of human resource reallocation processes during the restructure, withoutunnecessary recourse to additional hiring; and (iii) agree to guiding principles for the upcoming remunerationreview to ensure that the recommendations of the review are consistent with ongoing fiscal sustainability.

5 ADB. 2011. Report and Recommendation of the President to the Kingdom of Tonga for the Proposed Grant ofthe Tonga-Fiji Submarine Cable (Tonga). Manila. This project is co-financed by ADB ($9.7 million), the WorldBank ($16.5 million), and Tonga Cable Limited.

6 In interviews, government officials claimed that there had been a sharp rise in cases where consumption taxreturns were incorrect, while private sector business owners felt that this was a stratagem to delay refunds.


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While the government undoubtedly needs to improve revenue collection, it should not do sowithout considering the impact on the private sector. While tax evasion should be prosecuted,if the government simultaneously owes tax refunds to the very firms that it is pursuing forrevenue payments, the impact is bound to be negative. Moreover, attempting to raise revenue,

which is being spent on public sector wages and salaries, will not increase the willingness ofthe private sector to cooperate. In all countries where good quality governance exists, thereis an implicit compact that the public sector provides value in the form of public goods andservices. If these appear to be deficient, then the compact breaks down.

Furthermore, there is evidence that public spending that is dissipated in the form of publicsector wage and salary spending has little stimulus impact on the economy compared withinfrastructure investment, which is needed urgently. Bringing the wage and salary bill undercontrol is a matter of critical priority.

A further issue results from the increase in taxes (Box 1) and business license fees to raiserevenue, combined with much more vigorous enforcement. Tongas system of businesslicensing harms the private sector and discourages investment, which over the longer termwill reduce government revenue. The health of Tongas economyand the funds available tothe government to implement social programsdepends on a vigorous private sector thatactively invests. Viewing business simply as a source of revenue will ultimately harm bothinvestment and government income.

Thus, the global economic crisis has adversely affected Tongas private sector both directly,through lower domestic demand, and indirectly, through various other channels, includingtaxation, licensing, and government purchasing.

Policy Continuity

The government that was formed in 2011 following the introduction of full democracyemphasized that its policies will reflect continuity with those of the previous government.The business community affirmed that they preferred to have no radical change in policyreform initiatives. They also recognized the constraints under which the new government hadbeen placed by the global economic crisis. In addition, the business community expressedthe hope that the positive reforms that had begun under the previous government wouldbe continued.

Box 1 Higher Taxes, Lower Revenue

The new liquor licensing rules were amended in late 2010 and came into force on 1 January 2011, without anyformal consultation with affected private sector interests. The new rules, which reduced the hours licensed premisescould serve alcohol to the public, were introduced soon after the excise tax was increased by 5% in October 2010.In August 2011, the excise on imported beer was increased by 20%. The combined impact of these changes hasseen beer sales decline by 47% over the January to March 2011 period against the same period in 2010. It has beenreported that some businesses in the hospitality industry have lost almost 20 trading hours per week as a result ofthe changes.

Source: J. Sullivan, Director, AJ & E.


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Recent Reforms to Promote Private Sector Development

Tonga has been one of the Pacific regions leading reformers in a number of areas. 7 In manycases, reforms followed the recommendations of the 2008 PSA (see the Appendix for acomplete list of recommendations and private sector-oriented reforms). Since this documentupdates and extends the PSA, it is instructive to compare reform priorities outlined in the earlierdocument with what has been achieved. The next section outlines the recommendations andprogress to date. The most important include:

amendment to the Companies Act 1995, to more closely reflect Tongas needsand to provide for an electronic registry. The International Finance Corporation(IFC) funded an interim electronic solution to support the company registry. AsianDevelopment Bank (ADB), through the Private Sector Development Initiative (PSDI),is providing financial and technical assistance for the installation of an electroniccompany registry during 2012;

reform of the Personal Property Securities Act 2010 and a new electronic registrythat went live in April 2011;

rationalization of a number of SOEs; introduction, in 2010, of amendments to the Public Enterprises Act 2002 (Public

Enterprises Act), which specify the principal objective of SOEs and the way in whichthey should be organized, and include enhancements to corporate governance rulesas well as the roles and duties of directors and managers;

initiatives to improve the corporate governance of SOEs; and corporatization of the biosecurity heat treatment facility, which is being primarily

funded by the Government of New Zealand.

Both private sector and public sector stakeholders indicated strong support for the reforms.Despite the decline in consumption expenditurewhich has adversely impacted their

businessesprivate business owners indicated that the reforms have provided a strongfoundation for future economic growth. Senior government officials interviewed expressedsimilar views.

Examples of how the reforms are being implemented include:

The Minister of Public Enterprises has been using the criteria set out in the PublicEnterprises Act to insist that Tongan SOEs improve their performance.

All ministers have resigned from the SOE boards, as required by the amended PublicEnterprises Act, and have been replaced by private sector directors.

Banks have transitioned to the new secured transactions framework. In doing so,they found a number of instances of property that had been pledged to several

people simultaneously, something that would not have been discovered under theold system.

7 Many of these reforms were supported by ADB through the PSDI and associated technical assistance projects,as well as technical assistance provided by other development partners, including the Australian Agency forInternational Development (AusAID), the IFC, and the Government of New Zealand, through the New ZealandAid Programme.


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The revised Companies Act has substantially reduced the time it takes to establishcompanies and has improved the transparency of the process. The speed ofregistration will improve markedly with the new electronic company registry.

Nevertheless, much remains to be done before Tonga has a business-friendly environment.The government still has a pervasive and dampening impact on the private sector, particularly

regarding the issues surrounding the licensing regime. During the 2012 Tongan EconomicDialogue, the private sector expressed the view that government employees do not providegood service and treat business with suspicion. These issues take place against the deepeninggloom on the part of the private sector with respect to its economic prospects. A NationalReserve Bank of Tonga survey 8 of the private sector shows that expectations are for furtherdeterioration in economic conditions, with the manufacturing, wholesale and retail, andtourism sectors all anticipating that the economy will worsen.

8 J. Mafi. 2012. NRBT Economic Dialogue: Growing our economya collective effort (Setting the Scene: CurrentEconomic Conditions, Outlook and Macroeconomic Challenges). Presentation at the 2012 Economic Dialogue.Nukualofa, Tonga. 78 March.


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Reducing Constraintsto Private Sector Developmentand Reform Progress in Tonga

The 2008 PSA included the following principal recommendations for reform. Progress in eacharea is shown below the recommendations. The Appendix contains a complete list of the

recommendations and progress achieved to date.

Recovery from the Shock of the Civil Disturbances

In 2008, the government announced that the center of Nukualofa would be rebuilt utilizingcombined grants of A$15 million from the governments of Australia and New Zealand anda concessional loan of CNY440 million from the Peoples Republic of China (PRC). The PSArecommended that the government should carefully supervise the quality of construction. Inthe main, this has occurred. The rebuilding of the central business district (CBD) in Nukualofa isnow complete.

The Rebuilding of Nukualofa

Ten major construction projects have commenced since 2008, which include the reconstructionof Vuna Wharf, the construction of the last phase of Vaiola Hospital, the renovation of theRoyal Palace, construction of a new branch of the ANZ Bank, reconstruction of Tungi Arcade,repair and reconstruction of infrastructure in the CBD, and construction of the Taumoepeau,Royco, and Sanft office complexes and the Molisi supermarket.

Due to robust contracting and good project management, this activity has generated somepositive benefits for the local economy, at least through first round effects. And althoughthe loan from the PRC was linked to the China Civil Engineering Construction Corporation,the contract required the employment of local workers unless it could be proved that theskills required could not be found within the Tongan labor market. Further, the cabinet setup the Nukualofa Development Council, a subcommittee to provide project managementoversight. The Nukualofa Development Council has been successful in ensuring, for themost part, that buildings meet local building standards and are of an acceptable quality. In anumber of cases, construction was contracted out to third-party providers. For example, thereconstruction of Vuna Wharf was subcontracted to Fletchers Construction, a New Zealand-based and internationally recognized construction company.


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Related Issues

While construction activity has had some immediate economic benefit and will result insignificantly upgraded infrastructure and office accommodation in the CBD, there arepotentially negative longer-term issues. The construction has more than doubled the availablestock of commercial real estate in the center of Nukualofa in an environment of generaleconomic downturn, in which both the government and the private sector are looking toreduce costs. In late 2011, the Public Services Commission, for example, repudiated a 3-yearcommitment to Tonga Post to lease over 440.5 square meters (m 2) of office space at T$250/ m2. The Public Service Commission moved into the Prime Ministers office complex on arent-free basis.

These issues are compounded by the need to service the loan from the PRC. To provide theprivate sector borrowers with some comfort that they would be able to service the loansused to finance the redevelopment, 9 the government agreed to underwrite up to 1,000 m 2 of rental space per building, up to a total of 5,000 m 2 over the total reconstruction project.Much of the newly created space remains empty, with the corresponding implication thatthe government will be required to fulfill its guarantee and pay the rent. In the medium tolong term, the exposure of the government to contingent liabilities from the rebuilding issubstantial. The rental underwrite could amount to T$1.5 million per year, 10 payable for thefull 30-year term of the loan. The governments financial exposure will also increase to theextent that the private sector is unable to meet its interest and principal obligations underthe on-lending loan arrangements. Tongan officials have indicated that it should be possibleto service the debt until the deferred interest payments begin, which will commence 5 yearsafter the initial drawdown of a series of tranches was made in September 2008. At thatpoint, however, without significant economic growth, there could be difficulties making thenecessary repayments. 11

Reducing the Presence of the State in the Economy

The 2008 PSA identified the pervasive presence of the state in the economy as one ofthe important determinants of the poor performance of the Tongan economy in terms ofproductivity. Tonga then participated in comparative studies of SOEs in several Pacific countriespublished in 2009, 2011, and 2012, which concluded that SOEs:

are a drag on growth; crowd out the private sector; and provide costly and inefficient infrastructure. 12

9 The government has entered into on-lending loan agreements with the private sector borrowers, whereby theterms of the loan between the government and the PRC lender are generally matched.

10 The underwriting contract does not specify the per square meter rate, but links it to current market rates. Atthe time of providing the guarantee, the government based its analysis on a rate of about T$300/m 2.

11 Remark by Samiu Vaipulu, Acting Prime Minister of Tonga, as reported in Chapman, Kate, Chinese Loan Likelyto be Hard Going for Tonga. http://www.stuff.co.nz/world/south-pacific/5281034/Chinese-loan-likely-to-be-hard-going-for-Tonga (14 July 2011).

12 ADB. 2009. Finding Balance: Making State-Owned Enterprises Work in Fiji, Samoa, and Tonga . Manila; ADB.2011. Finding Balance 2011: Benchmarking the Performance of State-Owned Enterprises in Fiji, MarshallIslands, Samoa, Solomon Islands, and Tonga . Manila; and ADB. 2012. Finding Balance 2012: Benchmarkingthe Performance of State-Owned Enterprises in Papua New Guinea . Manila.


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State-Owned Enterprises Are a Drag on Growth

Calculations, shown in Table 1, estimate that SOEs tie up 15%31% of the total fixed capitalstock of the whole Tongan economy. 13 Even using the low end of the estimate, it is clear thatthe state owns and controls a substantial portion of the capital stock in Tonga. Currently,the contribution of SOEs and their capital stock to GDP is substantially less than it shouldbe. Best estimates show that SOEs contributed only about 6% to GDP in 2008, the latestyear for which data are available. 14 The very low efficiency of SOEs constitutes a severe dragon growth. With more effective use of these assets, productivity and long-term economicgrowth would be far higher. Furthermore, inefficient SOEs raise the cost of doing businessfor the private sector, further reducing investment and growth.

While comparatively, the Tongan SOE portfolio has outperformed its neighboring islandcountries, 15 in absolute terms the portfolios performance has continued to decline year onyear, and only achieved a 2.5% return on equity (ROE) in FY2010, although the decline inperformance over the 3 years to FY2010 can be attributed to a number of one-off factors:

a number of issues 16 contributed to a significant reduction in earnings from TongaCommunications Corporation (TCC), which only achieved a 0.4% ROE in FY2010.In past years, it represented around 80% of the entire SOE portfolios net earnings.However, the profitability of TCC will be permanently impacted by the introductionof aggressive competition from Digicel in Tonga. There is no longer any justification

13 Exact estimates are highly dependent on the method used to calculate their capital, which accounts for their

wide range.14 SOEs contribute $0.27 to GDP for every dollar invested, compared to a contribution per dollar invested by the

private sector of $1.35.15 Finding Balance 2012 shows that Tongas SOE portfolio achieved an average annual return on equity for FY2000

FY2010 of 5.6%, compared with that of Fi ji at -0.6%; the Marshall Islands at -13.3%; Samoa at 0.3%; SolomonIslands at -11.0%, and Papua New Guinea at 4.2%.

16 Increased levies of T$2.4 million combined with increased costs driven by increased depreciation, provision fordebtors, and network enhancements.

Table: State-owned enterprise (SOE) Impact Data

SOEs as a proportion of total fixed assets in the economy 15% to 31%

SOE contribution to gross domestic product (GDP) 5.5%

Contribution to GDP per $1 of investment in SOEs $0.27Contribution to GDP per $1 of investment in non-SOE sector $1.35

Average GDP growth rate for the economy Fiscal Year (FY)2002FY2008 1.1%

Impact of SOEs on GDP growth rate -1.12% to -0.41%

Average return on equity of all SOEs FY2002FY2010* 5.6%

Average return on assets for all SOEs FY2002FY2010* 3.4%

Number of SOEs 13

* FY2002FY2010 actual figures drawn from ADB. 2012. Finding Balance 2012: Benchmarking the Performance ofState-Owned Enterprises in Papua New Guinea. Manila.

Sources: ADB. 2011. Finding Balance 2011: Benchmarking the Performance of State-Owned Enterprises in Fiji,Marshall Islands, Samoa, Solomon Islands, and Tonga . Manila.

Table 1 Economic Impact Indicators for State-Owned Enterprises in Tonga(2008 Estimates*)


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for the government to own a telecommunications provider, and it should considerprivatizing TCC, in whole or in part. The sale of the asset will also provide muchneeded revenue to the public sector;

significant losses from the interisland ferry company, relating to the sinking of thePrincess Ashika ferry; and

the addition of two new SOEs (Tonga Airports and Tonga Power), which have verylarge asset holdings, but achieved low returns in their first period as SOEs. 17

The statistics in Table 1 demonstrate powerfully the negative impact of the current SOEportfolio on the competitiveness of the Tongan economy.

17 As of end 2011, the cost of power in Tonga was T$0.98 per kilowatt-hour (kWh). The government agreed inMay 2011 to subsidize the first 100 kWh by T$0.11 for 3 months. This affected 63% of Tonga Power consumers.

Box 2 Privatization

An argument frequently put forward against the privatization of state-owned enterprises (SOEs), particularly thosethat are profitable, is that the government will lose the benefit of the ongoing dividend payment. In 2007, thegovernment sold its 75% shareholding in Leiola Duty Free, at the time one of the most profitable SOEs. Was thisa bad decision?

A presale valuation of Leiola Duty Free, commissioned by the government and undertaken by PricewaterhouseCoopersin May 2007, indicated a sale range of T$3 millionT$4 million for the governments 75% interest. The governmentsshares were actually sold for T$6.6 million, a 65% premium over the top of the valuation range.

From fiscal year (FY) 2002 to FY2006, the total net profit for Leiola Duty Free was T$0.14 million, T$0.29 million,T$0.65 million, T$0.79 million, and T$0.46 million. The non-audited profit for FY2007 was estimated to be T$0.99million. The total profit for FY2002FY2007 was T$2.25 million; however, the governments share was only 75% ofthe total T$1.69 million. Disregarding the net present value of money, it would take 4 years of average profitabilitybefore the government would be better off retaining its investment in Leiola Duty Free rather than sell. However,even this analysis is too simplistic, for the following reasons:

The analysis is based on profitability. However, in cash flow terms, the dividend flow is more important. There isno guarantee that 100% of profit will be paid out in dividends.

Cash in the bank today is always more valuable than the promise of cash in the future. The government eliminated its exposure to the commercial and business risks associated with its investment in

Leiola Duty Free.

The government was able to redirect the sales proceeds into other government activities such as repaying debt orinto important social needs such as health and education, which arguably have a greater economic value than acommercial investment.

Source: ADB analysis of data provided by the Ministry of Public Enterprises.


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State-Owned Enterprises Crowd Out the Private Sector

The problems of low productivity are compounded by the crowding out of the private sectorin areas such as telecommunications, printing, waste collection, broadcasting, and financialservices where the private sector competes directly with some SOEs. However, these SOEs donot operate on a commercial basis. They have access to subsidized loans and generate low

dividend yields,18 thereby crowding out their private sector competitors, which must achievea risk-adjusted ROE for their owners and pay commercial interest rates on their debt. Not onlydo private sector operators have to compete with subsidized SOEs, but also some governmentdepartments that engage in commercial activities. The former Ministry of Works and DisasterManagement, 19 for example, undertook a commercial septic tank emptying service in directcompetition with private sector firms. In mid 2011, the truck used to empty septic tankswas transferred from the Ministry to an SOE, Waste Authority Limited, enabling the SOE toundercut the pricing of the competing private sector providers.

State-Owned Enterprises Provide Costly and InefcientInfrastructure Services

Power, water, airport, and port services are provided by SOEs throughout the country. Forvarious reasons, the costs of these services are high even in comparison with the high cost ofinfrastructure services in other Pacific countries. Figure 3 (below) shows the relative cost ofpower in Pacific island economies, normalized on Solomon Islands, which has the highest costof electricity to commercial users in the region. The cost of electricity in Tonga is approximately80% of that in Solomon Islands, substantially above that in much smaller countries, such asNauru and Palau. Similar comparators, such as Samoa, have much less costly electricity. One ofthe reasons for the high cost of electricity in Tonga is the inefficient fuel transfer mechanism.Diesel oil, which provides the majority of energy for power generation in Tonga, has to betransshipped through Fiji onto smaller tankers because storage capacity in Tonga is limited.As a result, the landed cost of diesel is high. Although development partners are subsidizingalternative energy facilities, the installation of a fuel tank farm, consisting of large storage

tanks, together with other initiatives such as an oil price risk management strategy and amore efficient fuel supply chain, would go a long way toward reducing the cost of electricity.According to some estimates in Tonga, this would result in savings of 20% on the cost ofelectricity, which would bring the cost of power to below the regional average. 20

Tonga is committed to moving from a virtual total reliance on diesel for electricity generationto a greater use of renewable energy sources. The Tongan Energy Road Map (TERM),which was adopted in 2010, set an ambitious target of achieving 50% renewable powergeneration by 2012. TERM has been a successful mechanism to enhance donor coordinationand interaction with the government. Tongas major donor partners have agreed to workwithin the TERM structure.

18 Finding Balance 2011 shows that the Tongan SOEs average ROE and cost of debt for the FY2002FY2009period were 5.8% and 6.1%, respectively. Further, during that period, the government injected an additionalT$15 million into the SOEs.

19 Following the Government of Tongas restructure of ministries in July 2012, the Ministry of Works and DisasterManagement and the Ministry of Transport merged to become the Ministry of Infrastructure.

20 Estimated return on investment in a fuel tank farm is 15% per year.


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The majority of SOEs comprise smaller companies with total assets of $T5 million or less,some competing with the private sector. Six SOEs are in this category, namely, the TongaBroadcasting Commission, Tonga Market, Tonga Post, Tonga Print, Tonga Timber, 21 and theWaste Authority. These smaller SOEs require as much time for effective ownership monitoringas the larger SOEs. It is recommended that the government look to either merge these SOEs,formally or through the development of shared services; or privatize them, thereby reducingthe burden on monitoring resources and freeing up capital.

Details of the State-Owned Enterprise Reform Measures

Improving the efficiency of SOEs is an urgent policy priority for several reasons:

The government is increasingly resource constrainedmore efficient SOEs willcontribute to reducing the resource constraint.

Low productivity has been the major cause of low growth. Tongan SOEs, whichutilize capital inefficiently, have been one of the major factors in the poor growthperformance.

The competitiveness of the private sector is hampered by high costs of servicesprovided by SOEs.

21 Renamed Tonga Forest Products Limited in 2011.

Figure 3 Relative Commercial Electricity Costs in the Pacific

Country

Timor-Leste

Fiji

Papua New Guinea

Nauru

Samoa

Palau

VanuatuCookIslands Tonga Tuvalu

Kiribati

SolomonIslands

FederatedStates ofMicronesia

MarshallIslands

R e

l a t i v e

E l e c

t r i c i t y

C o s

t s ( S o

l o m o n

I s l a n

d s =

1 . 0

)

1.0

.9

.8

.7

.6

.5

.4

.3

.2

.1

0

Source: Pacific Power Association.


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The government has accepted the need for SOE reform and since 2008 it has, through theMinistry of Public Enterprises, made significant progress. The most notable reforms to datehave been the following:

The governments 75% shareholding in Leiola Duty Free was privatized in 2008, andall of the assets in Tonga Machinery Pool were sold and the company liquidated in

2009. The boards of 10 of the 13 SOEs were restructured in 2010, with all politiciansand civil servants serving as directors replaced with private sector appointees.The financial results for all SOEs for FY2008 and FY2009 were published in localnewspapers, in Tongan and English, including brief commentaries on each SOEs keyperformance drivers. The publication of financial results has continued as requiredby the 2010 amendment to the Public Enterprises Act 2002, which is a major steptoward improved transparency.

Rationalization strategies have been developed for all 13 SOEs with assistancefrom ADB.

An amendment to the Public Enterprises Act 2002 was enacted in October 2010,introducing significant enhancements to the SOE legislative framework in Tonga.The major enhancements were:

The introduction of a principal objective for all SOEs to operate as successfulbusinesses, which is defined as being as profitable and efficient as businessesnot owned by the state;

Robust community service obligation provisions that require a writtenagreement, full costing (including a profit margin), transparency, and a clearstatement that the government must provide a formal direction to the SOE toundertake a community service obligation before it can be funded;

Enhanced directors duties and obligations that make it clear that all decisionstaken by directors must be consistent with the principal objective of operatingas a successful business. Provisions dealing with conflicts of interest establishedin the Companies Act were imported into the Public Enterprises Act, so that

they now apply to company and non-company SOEs alike; Improved transparency and accountability in relation to an SOEs key planning

documents such as the business plan, which includes the requirement that asummary of the annual report, prior years budget, and next years forecastsbe published in local newspapers;

A prohibition on the appointment of politicians as SOE directors; 22 and

Where civil servants are appointed, only one can be appointed to any givenSOE, and never as the chairperson.

The amendment to the Public Enterprises Act 2002 also established a processwhereby the Ministry of Public Enterprises could be restructured into an SOE holdingcompany, with all or some of the SOEs transferred into the holding company as

subsidiaries. In June 2011, the Minister of Public Enterprises successfully applied to have the

joint venture company 23 that owns the International Dateline Hotel placed into

22 However, ministers may be appointed to the board of start-up SOEs for 12 months.23 The joint venture company is 49% owned by the Government of Tonga and 51% owned by a PRC SOE.


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liquidation by the court. This should allow the government to regain control ofthe hotelonce it has proven its loan to the liquidators satisfactionand thenseek private investment or ownership to reestablish the hotel as a high-qualityaccommodation facility. The government awarded the role of sales agent to theInternational Finance Corporation (IFC).

Tonga Power was established in 2008, when the generating equipment andinfrastructure was repurchased from private owners. It made a 2% ROE in FY2009.In FY2010, the companys financial position improved markedly as a result ofimproved governance and a clear commercial mandate. It achieved an 8% ROEwhile generating sufficient cash flow to invest T$5 million back into the businessand pay the government a T$1 million dividend. It also reduced accounts that wereoverdue 30 days or more, from T$2 million at the beginning of FY2009 to onlyT$174,539 at the end of that financial year.

The financial performance of the SOE portfolio is expected to improve over the next fewyears, provided that the government fully implements the provisions of the Public EnterprisesAct and continues with the reform agenda. Indeed the FY2010 ROE of 2.5% showed asolid improvement over the -0.4% ROE recorded in FY2009. Tonga Power achieved a profitof T$3 million (an 8% ROE) for FY2010 and Tonga Development Banks profit for the sameperiod was T$1.5 million (also an 8% ROE).

The Minister of Public Enterprises made it clear that directors will be held accountable forpoor financial and operational performance, and for timely reporting, as required under thePublic Enterprises Act. His resolve was illustrated by the restructuring of the boards of twononperforming SOEs in February 2011, although the cabinet subsequently reversed one ofthese restructurings.

However, the Ministry of Public Enterprises and many of the SOEs are constrained by ashortage of qualified personnel, which could frustrate the expected improvement in SOEperformance unless the government adopts a more strategic approach to its ownershipinterest in the SOEs.

Downsizing the Civil Service

Despite the recognition that the public sector payroll constitutes a drain on the budget,little progress has been made in reducing the financial burden of the civil service on overallgovernment expenditure (Figure 4). Furthermore, salaries and wages (including retirementcontributions) have risen sharply as a percentage of current expenditure since 2008. Essentially,the government has been cutting back on other necessary spending in order to maintain thesalary and wage bill. 24

While ensuring that wage policy is transparent and predictable, other measures that thegovernment had been considering as part of the policy implementation have not yet been

put into place. For example, the salary and wage package initially included abolishing morethan 500 vacant positions in the civil service, which would have placed a potential ceiling onthe public sector wage bill. This has yet to be implemented. Furthermore, the government hasembarked on a rationalization of ministrieseffective 1 July 2012combining, for example,

24 Although as a percentage of GDP, the public sector payroll, including provident fund contributions, has decl inedfrom its peak. Nevertheless, it remains substantially above 2008 levels.


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the Ministry of Tourism with the Ministry of Labour, Commerce and Industries (to create theMinistry of Commerce and Tourism). Plans to combine the Ministry of Finance and NationalPlanning with the Ministry of Revenue Services were abandoned, leaving these as stand-aloneMinistries.25 However, in announcing the rationalization program, the government advisedthat there would be no corresponding reduction in civil service numbers. 26

The impact of wage policy on the private sector has been substantial. First, the pressureon the budget, an increasing part of which is made up of salaries and wages, has ledto the implementation of stringent tax policies including the delays in consumption taxrefunds mentioned above. Second, the high wages in the public sector have the unintendedconsequence of increasing salaries and wages in the private sector, but not as a result ofproductivity improvements. Third, other government purchasing from the private sector hasbeen reduced to meet the public sector wage bill.

The government has recognized the drain that the wage bill places on public finances and is inthe process of reviewing wage policies to reduce the overall burden on the budget. Measuresto reduce the impact on spending need to be adopted without delay.

25 Information from the Tonga Government Portal. http://www.pmo.gov.to/government (viewed on10 October 2012).

26 Matangi Tonga . Government Creates Jobs by Not Reducing the Size of the Civil Service. 11 January 2012.http://matangitonga.to/2012/01/11/government-creates-jobs-not-reducing-size-civil-service (viewed online on10 October 2012).

Figure 4 Public Sector Wage and Salary Bill(% of Current Expenditure)

P e r c e n

t a g e o

f C u r r e n

t G o v e r n m e n

t E x p e n

d i t u r e

60

55

50

45

40

35

2008 2009

Fiscal Year

2010 2011 2012

Source: International Monetary Fund. 2011. Tonga: Article IV ConsultationStaff Report; Staff Supplement; Public InformationNotice on the Executive Board Discussion; and Statement by the Alternate Executive Director for Tonga . Washington, DC.


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Improving Infrastructure

One of the functions of an effective government is to provide quality infrastructure in the mosteffective way. The 2008 private sector assessment (PSA) concluded that poor infrastructureadded substantially to the costs of doing business in Tonga. However, in the subsequent 3years, the quality of physical infrastructure in Tonga deteriorated further in a number of areasas budget pressure and claims on revenue from public sector salaries drained resources frommaintenance and additional construction.

Roads

Following the governments decision in 2008 to retrench all of the then Ministry of Worksand Disaster Managements daily paid workers involved in road maintenance in order to savemoney, little road maintenance has been undertaken on Tongas roads. The governmentsintention was to contract out road maintenance, but as the budget constraints tightened inFY2009 and FY2010, contracting out did not occur. As a result, the quality of some roadshas steadily deteriorated.

However, additional maintenance and construction projects are now progressing. TheGovernment of the PRC has provided a grant to resurface a number of secondary or feederroads on the main island of Tongatapu, and a concessionary loan for road maintenance withinNukualofa and throughout Tongatapu.

ADB has provided a grant of $11.3 million to upgrade two major access roads into Nukualofa.The project also involves upgrading the drainage and footpaths to minimize flooding andthe flow of pollutants into the adjacent lagoon. The first contract under this project wasawarded in August 2008, but the major roadwork component commenced in February 2011and construction was still underway in November 2012.

The World Bank and the Australian Agency for International Development (AusAID) agreed,

in December 2010, to provide $9.3 million under their existing Tonga TransportationConsolidation Project to address maritime issues and support road maintenance. Part ofthe grant will be directed at developing local road maintenance capacity. The grant will alsoprovide funding to undertake the maintenance work.

Shipping and Air Transportation

With the sinking of the Princess Ashika ferry in July 2009, Tonga was without full ferry servicesbetween its major island groups for over a year. While a private ferry operator provided serviceto most islands, the Niua Group was without a ferry altogether. Furthermore, the private boatswere much smaller than the Ashika. The replacement ferry, built by the Government of Japanand gifted to the Government of Tonga, did not commence service until late 2010. Therefore,for more than 12 months, trade within Tonga was severely restricted, with an adverse impacton economic activity and incomes of Tongans engaged in interisland trade.

The global economic crisis substantially reduced the level of imports into Tonga to a pointthat compromised the viability of some shipping lines. As a result, shipping services havebeen rationalized, and there is now a conference arrangement with a shipping frequency


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of 15 days that, in turn, has adversely affected the export market. For example, only 50% ofwatermelon crops are now export-viable.

The cancellation of the Air New Zealand weekly Boeing 767 return flight from Auckland to LosAngeles, which stopped in Tonga and Samoa, has also had an adverse impact on the exportof agriculture and fisheries products to Japan, New Zealand, and the United States. 27 Tonga

is now primarily served by Air New Zealands smaller Airbus and Virgin Samoas Boeing 737;neither of which have significant cargo capacity. In mid-2011, Air New Zealand recommencedusing the Boeing 767 on a biweekly Auckland to Tongatapu return flight, or when passengerand cargo loads warrant the flight. This means that exporters must work closely with theairline to ensure the larger plane is available when required.

A domestic air service is provided by a New Zealand-owned company, Chathams Pacific.The airline operates a fleet of aircraft including a Convair CV580, Metroliner, a DC3, and aQueen Air. The frequency of the services varies and, while the airline flies to all of the majorisland groups, some routes are only served every 2 weeks. The return adult airfares betweenthe islands of Tongatapu and Vavau, and Tongatapu and Haapai are T$462 and T$306,respectively. Apart from passenger luggage, very little cargo is carried on these services.Air Pacific announced in December 2011 that it would commence a return service from

Suva in Fiji to Tongatapu via Vavau, which should provide some limited competition fordomestic air services and increase cargo capacity. However, by November 2012, the servicehad yet to commence.

Telecommunications

Tonga is highly competitive in the area of mobile phones, with costs among the lowestin the Pacific. There are two main providers: Digicel and the government-owned TongaCommunications Corporation (TCC). Since its entry, Digicel has experienced explosive growthand now estimates that its market penetration is over 100% (i.e., there are more mobilephone subscriptions than the total of the population). TCC is the sole provider of fixed-lineservices, with over 9,500 clients, most of whom are commercial customers.

Digicel is innovating rapidly. In January 2011, it introduced Mobile Money, a mobile paymentssystem. By March 2011, the company had 15,00016,000 active Mobile Money clients.

Competition is also strong in internet services provision. However, due to limited capacitythrough the existing satellite connection, pricing has been high and connection speedshave generally been slow. Pricing incentives contribute to the slow connection speeds. Bothcompanies had originally based their pricing on connection speeds rather than volume, whichencouraged local DVD rental businesses to download videos and produce pirated DVDs forrent, thereby reducing the available bandwidth for other users. In 2011, TCC introducedvolume-based pricing to address this issue.

27 The governments of both countries stopped subsidy payments to Air New Zealand, which resulted in the servicebeing discontinued.


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Tongas prosperity is crucially dependent on its ability to connect with the outside world.ADB and the World Bank are cofinancing a project 28 (on a grant basis) to connect Tongato a submarine fiber optic cable. The total project cost is estimated at $34 million and thegovernment will be investing some $6.6 million into the project. The preferred link is via theexisting Southern Cross Cable, which would require a connect point in Fiji. The government iswell advanced in its planning and implementation. The contract to lay the cable was awarded

in May 2012 and it is expected that the cable will land on Tongatapu within the first quarterof 2013. If managed properly, this development could open up new business opportunities,such as the development of international call centers, and support growth in tourism andthe private sector in general.

Modernizing and Rationalizing Commercial Laws

The Companies Act and Registry

The 2008 PSA identified significant constraints arising from an incomplete commercial legalframework, including an outdated Companies Act, with the additional complicating factorthat the company registry was destroyed by fire in 2006. Company law experts, financed byADBs Private Sector Development Initiative (PSDI), worked with registry experts from the IFCto implement the necessary legal reform. After extensive consultation, an amendment to theCompanies Act was drafted which, among other matters, provided for the establishment ofa new electronic registry. The Legislative Assembly passed the Companies (Amendment) Actin September 2009, and the interim registry commenced on 1 December 2009.

However, due to the anticipated funding source becoming unavailable, a fully electronicregistry is not in place as yet. As a result, filing of information and searching is limited. Forthe long-term operational efficiency of the registry and ease of registration, implementationof a fully electronic registry is crucial. 29

The amendment to the Companies Act is not as comprehensive as some new Companies Actsin the region, in particular that in Solomon Islands, where the Act allows for the formationof companies that are particularly suited to the communal nature of Pacific countries. Forexample, in Solomon Islands, there is a provision for the formation of community companies,in terms of which communities can incorporate to manage business activities that are relevantfor the community as a whole, rather than those of individual entrepreneurs. Once theTonga Companies Act is fully functioning with the support of a complete electronic registry,consideration should be given to further amend the Act to emulate the more innovativeprovisions found in Solomon Islands.

Filling the Gaps in the Commercial Legal Framework

The commercial law in Tonga has many gaps, which impact significantly on the private sector.For example, in 2003, an amendment to the Civil Law Act 1996 removed all of the English

28 ADB. 2011. Grant Agreement for Tonga-Fiji Submarine Cable Project between Kingdom of Tonga and ADB.Manila.

29 An electronic registry funded by PSDI has recently been introduced in Solomon Islands. This enables the onlineincorporation of companies, filing of returns, etc. The registry also supports a robust search capability.


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statutes of general application from Tongan law. As a result, essential statutes such as theSale of Goods Act, the Trustee Act, and the Insolvency Act no longer apply in Tongan law.

Tonga needs to fill in the gaps in existing legislation, as recommended in the 2008 PSA. Inparticular, the absence of a Personal Insolvency Act increases the risks to lenders and damagesthe supply of credit more generally. An insolvency bill was presented to the legislature in

2009, but failed to pass. Resubmission of the bill is strongly recommended.The private sector would also benefit from codification of the general law of contract. Asoutlined above, the missing laws create considerable uncertainty for businesses and individuals,and this is acute when forming and enforcing contracts. A codified approach would provide asingle binding written text. It would improve accessibility, use, and enforcement of contracts.An earlier diagnostic reviewed the legal framework for contracting in Tonga and recommendeda form of codification. This recommendation received universal support from both privateand public sector stakeholders. 30

As part of this codification, the introduction of a legal framework for arbitration and electronictransactions should also be considered. There has been some work done on mediation, but amodern Arbitration Act with supporting institutions would facilitate rapid dispute resolution

and assist with enforcement. Essential to this would be reform of the enforcement of arbitral

30 ADB. 2009. Reforming Pacific Contract Law . Manila.

Box 3 Business Licensing Problems

Some quotes from a business owner regarding licensing problems

What I want to know is why I now need three licenses to operate, for example

to import my raw materials (surely that is inherent in running a business in Tonga); to trade (e.g., to manufacture goods); and

to export.

I was told I also need a retail license, though I have not taken this one up yet.

The above procedures are cumbersome and expensive. And to obtain all this, I also needed a tax clearance fromthe Internal Revenue Department.

Surely, one license should fit all aspects of your business. It is a bit like the restaurant/bar industry with the veryhigh licensing fees.

I thought the whole idea was to encourage tourism, not kill it, as they seem to so successfully be doing rightnow. Licenses require businesses to close early. But when we have people here, they want to go out while onholiday. And the closing hours wont affect road traffic accidents. People simply go through the back door to getwhat they want if they really wanted to.

Source: Remarks made in an interview with a Tongan entrepreneur.


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awards, both domestic and foreign. Given the growth in electronic transactions in all areas ofthe private sector, Tonga must give consideration to enacting an Electronic Transactions Actthat would ensure legal certainty for all transactions made electronically. Some countries in thePacific have already addressed the substantive issues regarding electronic transactions reform,and it would be advisable for Tonga to consider the approaches taken by its neighbors, whichare primarily based on the United Nations Commission on International Trade Law Model

Law on Electronic Commerce.

Removing the Barriers Created by the Present BusinessLicensing Regime 31

The 2008 PSA described the business licensing process as byzantine, involving numerousregulations that were difficult to comply with and which greatly increased the challenge/s ofdoing business in Tonga. It emphasized that the practice of licensing businesses by activitiesrather than by the business itself imposed substantial costs on the private sector. Unfortunately,little progress was made in this area until November 2011. Rather, it became more costly, withthe process seriously undermining the benefits of other reforms at a time when businesses inTonga were already facing severe problems because of the fall in demand (Box 3).

31 Editors Note: Subsequent to the PSDI support in drafting the Business License (Amendment) Bill, theTongan Parliament passed the Bill in October 2012 although, at the time of printing, the new Act is yet to bereleased for review.

Box 4 Visa Requirements for Foreign Investors

Applications must be lodged prior to arrival in Tonga. You must provide one recent passport photo (for all applicants included in the application). You must provide an application fee of T$345 and any other required fee(s). Please note that the fee must be paid

to immigration before application is referred to the Ministry of Labour, Commerce and Industries. Application form must be appropriately and fully completed. Please note that one family can share one form. Signed declaration (page 3 of the application form) the applicants signature is required (no sign for forms). You must provide a valid passport. You must provide a medical report (in accordance with the prescribed medical form) issued within the past

3 months. You must provide a National Police Clearance issued in the past 3 months (for persons over the age of 16) from

country of ordinary residence. You must provide two current character reference letters from two individuals who have known the applicant for

a significant period of time (referees full contact details to be provided, which will be verified by the visa of

Documents

Tonga Private Sector Assessment Update, 2012