February 4, 2009No. 2/09 - G HIGHLIGHTS OF CDB'S ACTIVITIES IN 2008AND ECONOMIC BACKGROUND AND PROSPECTS PART A - ECONOMIC REVIEW AND PROSPECTS1. International Economic DevelopmentsAfter five consecutive years of strong growth, the global economy entered a period of great uncertainty in 2008. In the first half of the year, the world economy was grappling with the commodities crisis, which manifested itself in high commodity prices particularly oil, as well as food. In the second half of 2008, more particularly in the last quarter, the United States (US) financial meltdown occurred, spreading rapidly to other markets within Europe and Asia. By the end of the year the crisis was starting to have significant effects globally, finding its way into the real sector through sharp declines in economic activity arrivals and layoffs. The US economy expanded by only 1.4%, its slowest growth rate since 2001, and was accompanied by significant shedding of labour, particularly in the manufacturing and Construction sectors. As a result, the average annual unemployment rate rose to 5.8% in 2008, the highest level in five years. Other advanced economies also showed signs of weakening during the year, though to a lesser extent than in the US. This was particularly noticeable in the United Kingdom (UK) and Eurozone, where banks continued the process of deleveraging, and in so doing, contributed to the uncertainty in the market, as fears heightened about further bank losses. The emerging and developing economies, which have been an important pillar of global performance, also experienced slower growth in 2008, mainly reflecting softening external demand. Consequently, global growth was estimated at 3.8% compared to an average of 5% from 2003 to 2007. The foreign exchange market was rather volatile in 2008, mainly reflecting shifting market expectations as the global financial crisis deepened. In the first half of the year, the US dollar depreciated against several major currencies, as prospects in developed economies were relatively more favourable. However, as contagion spread to these economies the dollar gained in value, resulting in an overall appreciation for the year. In response to the deepening crisis, governments and central banks implemented a number of initiatives designed to boost confidence, and jump start the economy. Initiatives included capital injections to financial institutions (FIs), government guarantees to safeguard short and medium-term liquidity positions, relaxing monetary policy and purchasing of bad assets, most notably the $700 billion (bn) proposal to purchase toxic assets of failed companies. The primary objective of these interventions was to stimulate intermediation by supporting an orderly process of deleveraging while safeguarding the interests of depositors and creditors alike. 2. Regional Economic DevelopmentsOverviewRegional economies grappled with a number of external shocks in 2008. These included the global financial crisis and the subsequent deceleration in economic activity in the Region's main trading partners, the passage of several weather systems, and the rising price of oil and other commodities in the first half of the year. Nevertheless, regional economies were able to post some growth, albeit at a slower pace than in 2007, as the fall-out from the global crisis has not yet been fully realised. Fiscal performances were mixed in 2008, as in some countries efforts to cushion the effects of rising oil prices and higher wages and salaries led to deterioration in finances. Some countries did show improvements, benefitting from previous and ongoing fiscal reforms, while others reduced capital expenditures in the face of sluggish real sector activity. Against the backdrop of increasing uncertainty and rising liquidity and inflationary pressures, some central banks changed their policy stance, although the direction and the instruments used varied according to individual country dynamics. Available data on the external sector suggests that there were some reserve losses on account of widening current account deficits and falling capital account surpluses. During the year, the current account was affected by slowing Tourism activity and disruptions to agricultural exports, while the capital account suffered from declining remittances and foreign direct investment (FDI) flows. TourismFollowing a lacklustre performance in 2007, most countries registered either a decline or slower growth in arrivals in 2008. Dominica and St. Lucia were the notable exceptions, as Dominica benefitted from the staging of a national event which was supported by a large number of Dominicans, while St. Lucia partially recovered from the poor performance of the previous year. For most other economies the decline was particularly noticeable in the long-stay segment of the market. The global economic crisis, and in particular the financial turmoil in the US, the depreciation of the Euro and pound were the main factors contributing to the decline in international visitors, while intra-regional travel was adversely affected by high airfares. Only the Canadian market showed major improvement during the year and was likely reflective of the relative strength of that economy and the appreciation of the currency. In response to the decline in arrivals, some hotels engaged in discounting as a means of maintaining occupancy levels, while others were forced to lay off staff or reduce working hours. Cruise Tourism also deteriorated during the year as the global slowdown and high oil prices caused some cruise lines to adjust their schedules. AgricultureMost countries experienced growth in the agricultural sector in 2008, although this was concentrated mainly in secondary export crops, as sugar and banana production declined. Those non-traditional industries that showed some improvement were fisheries, citrus, cocoa, nutmegs, mace, vegetables, root crops, and livestock mainly on account of favourable weather conditions and higher prices on the world market. Sugar production is estimated to have declined in Guyana, Barbados, Belize, Jamaica and Trinidad and Tobago. In Barbados, ongoing efforts to restructure the sugar industry led to a reduction in the acreage under cultivation, while output in Belize suffered from adverse weather conditions and insect infestation. Output in Jamaica was affected by the passage of tropical storm Gustav, while in Trinidad and Tobago, there was no cultivation following Government's decision to close the sugar cane industry after the 2007 crop. In Guyana output was constrained mainly by unfavourable weather which affected planting and harvesting. Banana production fell in Jamaica, Dominica, and St. Vincent and the Grenadines, but rose in Belize, and St. Lucia. The industry in Jamaica was particularly hard hit by hurricane Dean in 2007 and tropical storm Gustav in 2008. These developments forced the island's largest producer to scale back operations and to focus exclusively on the domestic, rather than the export market. Production in St. Vincent and the Grenadines was also down due to the effects of Moko disease, adverse weather, rising input costs and a reduction in the UK retail price. The favourable performance in Belize, and St. Lucia largely reflected a recovery from the previous year's hurricane-induced slump. ManufacturingFollowing a favourable performance in 2007, manufacturing output declined in most economies in 2008. While the sector is relatively small, accounting for generally less than 10% of gross domestic product (GDP), its contributions to employment and foreign exchange are nevertheless invaluable. Regional production is limited to Construction materials, beverages, garments, jams and jellies, pharmaceuticals and detergents. The performance this year was adversely affected by slower global demand, and higher input costs, namely fuel and imported raw materials. Several manufacturers were faced with tightening credit conditions imposed by foreign suppliers who were now demanding upfront payment or more stringent settlement terms for raw materials.ConstructionActivity in the Construction sector moderated further, as most countries either registered a slowdown in growth or fall-off in activity. While this may reflect some return to normalcy following the extraordinary expansions associated with Cricket World Cup 2007 and the completion of other mainly public sector projects, this year's performance was also influenced by the global crisis, as the credit crunch led to reduced inflows mainly for hotel and condominium Construction. Much of the impetus for the regional performance came from the public sector where activity focussed on improvements to roads, hospitals and schools, while in the private sector work continued on residential Construction. Mining and QuarryingThere was a general increase in mining and quarrying activity in the Borrowing Member Countries (BMCs) in 2008. In Guyana, output expanded due to favourable conditions on the world market, and the reaping of gains from previous years' investments. More specifically, in the bauxite industry, significant investments over the last two years led to higher bauxite production, while the high price of gold on the international market coupled with favourable weather conditions led miners to expand operations. Diamond declarations decreased however, as the high price of gold, as well as the incentives offered to prospect for other minerals shifted activity away from diamond mining. In Trinidad and Tobago the energy sector is estimated to have slowed as a decline in oil exploration and production, on account of maturing oil fields, partially offset an increase in refining activity. Conversely, activity contracted in Jamaica as declining export prices in the bauxite and alumina market coupled with weak global demand led to an accumulation of inventories. InflationInflationary pressures continued to mount during the year as economies grappled with a number of external and domestic shocks. On the external front, countries had to deal with the rising price of oil and other commodities, in particular wheat and corn which are used in the production of flour and cereals. On the domestic side, factors included higher government spending, increased fees for some government services and adverse weather conditions which disrupted agricultural production. Consequently, higher prices were recorded for most categories in the price index, particularly, food, beverages, fuel and light, transportation, housing and furniture. To mitigate the impact of the rise in prices, especially on the more vulnerable groups, some governments implemented a number of measures. These included the zero-rating of food items in Antigua and Barbuda, Dominica, and Guyana, while in St. Kitts and Nevis the Government reduced customs service charges on basic food items, instituted a policy of fixing maximum profit margins that wholesalers and retailers could gain from the sale of some food items, granted concessions to bakers to ensure that bread remained affordable, and reduced the duties on imported food barrels. Guyana also lowered tariffs on fuel to combat high prices and maintain competitiveness.Financial SectorRegional monetary policy was conducted in a particularly challenging environment in 2008, characterised by global uncertainty, higher prices and slower economic growth. As such, the policy responses were varied, reflecting the dynamics in the individual BMCs - some central banks opted to tighten monetary policy, while one relaxed its stance, and others opted to leave policy unchanged. In Jamaica, maintaining exchange rate and price stability was the primary focus of monetary policy. Consequently, the Bank of Jamaica issued a Variable Rate Certificate of Deposit and injected foreign currency into the system in an attempt to tighten Jamaica dollar liquidity, raised interest rates on a variety of open market instruments, and re-introduced the 365-day tenor. Against this backdrop, growth in the money supply was lower than expected and likely reflected reduced demand in the wake of rising unemployment and lower real wages. Similarly, the demand for personal loans also waned, due to a reduction in the demand for motor car and home improvement loans. High levels of liquidity in Trinidad and Tobago's banking system and concerns about high inflation rates saw authorities utilising a wide range of instruments to mop up excess balances. These included: the issue of liquidity absorption bonds; increasing the reserve requirements applicable to commercial banks; the aggressive use of open market operations; raising of the repo rate by 75 basis points; and the rolling over of the commercial banks' compulsory deposit facilities that were due to mature. The rise in commercial bank liquidity was due to two main factors, namely the strong increase in net domestic fiscal injection by 3.8% to $2,023.5mn, and the amalgamation of RBTT Holdings Ltd. and RBC Holdings (Trinidad and Tobago) which placed $415.6mn in the financial system. Barbados' banking system also experienced high levels of liquidity, mainly reflecting relatively slower credit growth in the wake of decelerating economic activity. Consequently authorities reduced the minimum deposit rate twice, first by 50 and then by 25 basis points, and lowered the discount rate by 125 basis points. Fiscal PolicyFiscal performance was mixed in 2008. Several countries experienced a deterioration in public finances, as expenditures were notably higher on account of payments for salary increases, interest payments on accumulating debt stock, the inflationary impact on the prices of goods and services, larger transfers and subsidies due to efforts to mitigate the effect of rising prices, and in one instance, pre-election spending. Of those countries which registered an improvement in overall deficit positions, some benefitted from on-going and previous programmes to improve finances and financial management. This was particularly noticeable in Belize and Dominica which witnessed some increase in revenues, while managing to restrain expenditure growth. In most other countries where a favourable fiscal outturn was recorded, it reflected in large part, a reduction in capital spending as revenue growth was relatively slow. ProspectsThe prospects for regional performance in 2009 are heavily weighted towards the downside, as global growth is projected to decelerate to 0.5%. Indeed in the US, where the financial crisis originated, the economy is expected to contract by 1.6%. Similarly, the EU, UK and Japan are also expected to fall into recession in 2009. The length and depth of the recession will depend on the extent to which the process of asset deleveraging will continue, and the willingness of banks to resume lending to households and businesses. One of the main challenges confronting the intermediation process is the credit-worthiness of borrowers given the decline in households' net worth and the fall off in business income. It is likely that developed economies will introduce more measures in 2009 which may take the form of further interest rate reductions, additional capital injections into troubled FIs, or an increase in capital projects. On the upside, inflation has moderated in line with the decline in commodity prices, (although there may be a risk now of deflation) and some growth may still take place in emerging markets especially in Asia, as these economies have proven to be more resilient. The global crisis is affecting the Region through the financial and productive sectors. Although some spill-over into the financial sector has occurred, the impact on the real sector may be more significant and pervasive. The Tourism and Construction sectors may be most severely impacted by these developments, as vacationers will become more averse to travel in the wake of uncertainty about disposable incomes, while the Construction sector could be affected by lower FDI flows. Domestic demand is also likely to be affected through reductions in remittances, the impact of which will be felt mostly in poorer households. It is mainly through a reduction in real sector activity and subsequently, slower deposit growth that the financial sector will experience the second round effects of the global crisis. Should deposit growth decelerate, it is likely that there will be some reduction in credit to households and businesses. With respect to the external sector, while some savings may be reaped through a reduction in import prices assuming that oil and other commodity prices remain at current levels, these gains are likely to be offset by greater reductions in Tourism revenues and FDI, thereby worsening the overall balance of payments position. In terms of public finances, this year will be a particularly challenging one for regional governments as they try to maintain acceptable levels of service in a situation where revenues are likely to be declining. Some governments have indicated that in an attempt to shore-up domestic demand, they will engage in counter-cyclical spending, while others may seek to curtail expenditures to maintain fiscal positions. The Eastern Caribbean Central Bank Monetary Council and the Organisation of Eastern Caribbean States Secretariat have indicated that subject to conditions, member states will provide a package of short-term tax relief to the hotel industry, as the circumstances in each country warrants. Additionally, a number of long-term measures have also been enunciated to address challenges and spur growth in the Construction, fisheries, and transportation sectors among others. The Caribbean response to the crisis will need to be at three levels - the national level, institutional and the individual. Countries will need to assess the possible contagion channels and as a result put contingencies in place to mitigate the possible fallout. At the institutional level firms may need to be more cautious about expanding at this time and take a defensive stance. Institutional investors are also defensive and are switching to lower return, and lower risk options to minimise the impact on net asset values. At the personal level, individuals may need to postpone some consumption and investment expenditures to mitigate the impact of any adverse effects on households. PART B - CDB'S PERFORMANCE IN 2008The Caribbean Development Bank (CDB) in 2008 was able to sub-stantially increase its assistance to its Caribbean member countries. Loans and grants approved increased from USD210 million in 2007 to USD347 million in 2008. Both more developed countries (MDCs) and less developed countries (LDCs) benefitted. The CARICOM MDCs obtained approximately 52% of the total and the CARICOM LDCs (including Haiti and the OECS) obtained 37%. Regional projects and related activities received 10% of new financing. Haiti, which acceded to membership of CDB in 2007, received focussed attention. CDB approved non-reimbursable grants totalling USD11 million in 2008 for education and training and for urban community development. The education and training projects which are concentrated on technical and vocational education, management capacity in small and medium-sized enterprises, and project cycle management for public officials follow upon a substantial investment of USD10 million in primary education under the Education for All project financed in 2007. The Urban Community Development Project is primarily intended to improve basic and social infrastructure, social services and income generating opportunities for residents in selected disadvantaged areas. In addition, it will improve governance and management capacity. Another highlight of financial operations in 2008 was the Bank's expanded role in supporting fiscal stability and debt management through the provision of policy-based loans. In 2007, the Bank had played a major role in the provision of budgetary support and debt management in Belize and St. Kitts and Nevis. In 2008, it approved USD130 million in policy-based loans. CDB took the lead in orchestrating a joint effort with the Inter-American Development Bank (IDB) and the World Bank which will significantly relieve fiscal pressures on the Jamaica government and permit warranted programmes of capital investment and social expenditures to proceed. The CDB loan contribution is USD100 million. In addition, the Bank provided a policy-based loan of USD30 million to St. Lucia. As usual, the Bank approved financing for a wide range of economic and social development project activities and regional integration. Altogether, USD347 million was approved. In addition to the USD130 million (38%) for policy-based loans, 25% (USD85 million) was allocated to economic infrastructure, 13% (USD46 million) to human resource development and training, and 10% (USD36 million) to direct poverty reduction. USD 25 million (7%) in natural disaster relief and rehabilitation loans and grants were made to five countries: Belize, Dominica, Haiti, Jamaica and the Turks and Caicos Islands. On the last mentioned aspect, it is clear that the CARICOM countries have to cope with more frequent and intense windstorms and floods. The Bank will be revising its operating policies and procedures to be more responsive in the changed circumstances but has also attempted to emphasize the importance of climate change adaptation at its Annual Meeting in Nova Scotia, Canada, and has granted USD518,000 to support the work of the Caribbean Community Climate Change Centre which is located in Belize. The Bank addressed two other issues of growing importance, namely the global food price inflation which impacted the price level of BMCs and the global financial crisis and economic recession which has serious implications for economic performance and social progress in the Caribbean. Three major policy forums were convened to highlight the issues and point to appropriate policies. The highlights of fund mobilisation activities in 2008 were bond issues to CARICOM Central Banks and the successful completion of negotiations for the Seventh Replenishment of the Special Development Fund. CDB in November/December 2008 adjusted its capital mobilisa-tion strategy in light of the deteriorating situation in international financial markets by placing US dollar bonds totalling USD115 million with the Central Banks of all its CARICOM member countries to the mutual satisfaction of the objectives of CDB and the Central Banks. In December, negotiations for the Seventh Replenishment of the Special Development Fund (the Bank's main window for pursuing the goal of sustainable poverty reduction) were completed with pledged contributions totalling USD257 million compared with USD156.7 million for the Sixth Replenishment. Promotion of regional integration remained central to the Bank's activities in 2008. The Bank, having led the initial work for the establishment of the CARICOM Development Fund (CDF), ensured that the policies, rules and procedures for its operations were completed in time for the launch of the CDF in the last quarter of 2008. The success of the CDF will depend not only on financial contributions from member countries it will also rest heavily on the ability of the CDF to attract resources from outside the Caribbean Community. This will be greatly influenced by the demonstrable quality of the operations and governance arrangements of the CDF. Other activities in support of regional integration included a financial contribution for the operations of the Caribbean Regional Technical Assistance Centre, preparation of background papers on donor coordination, and technical assistance grants for the regional population census.- END -