Highlights of CDB'S Activities in 2006 and Economic Background and ProspectsPart A - Regional Economic DevelopmentsOverviewMacroeconomic conditions were generally good in CDB's borrowing member countries (BMCs) in 2006, as a high level of external and domestic demand continued to drive expansion in the region. The main contributions to economic growth across the region came from Tourism and Construction activity, although growth in business services and in agricultural output was important in a few countries. In Trinidad & Tobago, petroleum-related activities were the main drivers, although non-petroleum operations expanded strongly as well. The contribution from Tourism came despite moderate rates of expansion in the number of long-stay arrivals and a decline in the number of cruise visitors, and reflected increases in visitor expenditure. Construction sector activity was driven by a combination of factors, including reConstruction from past hurricane damage, investor expectations of continuing growth in Tourism, high domestic demand from prospective home-owners and from the business sector given a favourable medium-term outlook and active credit marketing by financial institutions, and by high levels of public sector investment, with the increase in spending by the public sector in some countries being partly driven by the need to improve facilities and infrastructure - particularly in relation to transportation and competition sites - in anticipation of the cricket World Cup competition early in 2007. This performance, however, took place within the context of generally higher prices owing to elevated oil prices, and in some countries, supply disruptions in the provision of agricultural commodities and higher tariff levels. Reflecting continuing growth in economic activity from 2004 and 2005, unemployment rates generally declined, leading to some wages pressure, particularly in the Construction sector, and to a continuing movement of labour to those countries experiencing high rates of growth.The rise in real sector activity was also reflected in an improvement in government revenues, which, coupled with efforts to improve tax administration and tax compliance, offset higher spending on social and physical infrastructure and on recurrent expenditures; as a result, fiscal outturns improved noticeably in most countries, although debt levels also increased in absolute terms as overall fiscal deficits were generally in evidence, and as countries borrowed to fund the capital programmes which generated the deficits. Despite a rise in financial system credit in most economies, indications are that there was still substantial excess liquidity in parts of the region, as deposit growth remained firm. Monetary authorities opted to raise interest rates as part of the effort to contain the growth in credit and relieve pressure on foreign reserves, and this was in step with the continued slow upward movement in international interest rates. The current account of the balance of payments deteriorated during the year as strong import demand, in line with the expansion in economic activity, outpaced growth in travel receipts; although a substantial portion of the expenditure was financed by foreign inflows, leading to a rise in gross reserves holdings across the region. Real OutputStrong economic growth in CDB's BMCs in 2006 was led by expansion in Tourism and Construction, and supported by agriculture, business and financial services, and manufacturing; in Trinidad & Tobago petroleum-related activities were a major contributor. With the exception of Montserrat, where heightened volcanic activity led to a reduction in economic activity, indications are that all other BMCs exhibited growth in 2006, with high rates recorded in Anguilla, Antigua & Barbuda, the British Virgin Islands, Trinidad & Tobago, and the Turks & Caicos Islands. Preliminary indications are that growth rates accelerated in nine economies while slowing moderately in seven. The Tourism sector, following some moderation in 2005, performed creditably in 2006 benefitting from a strong global economy, local marketing efforts and increased airlift, while in Construction, preparations for ICC CWC 2007 provided further support for an already vibrant sector. The manufacturing and agricultural sectors, while continuing to be plagued by high operational costs and unfavourable terms of trade movements, nevertheless were able to show some improvement in 2006. In agriculture, while some of the growth reflected a turnaround from previous year's unfavourable weather conditions, in other instances it was due to a concerted effort by government to expand existing facilities and provide support for farmers to improve agricultural practices. With respect to manufacturing, the sector was able to capitalise on heightened intra-regional and external demand to post notable growth during the year, while financial services was able to benefit from enhancements to the legislative and regulatory framework as well as on-going marketing efforts. With the exception of Trinidad and Tobago, elevated oil prices remained a challenge for most economies, which coupled with other inflationary pressures are likely to have constrained output growth in 2006. TourismThe Tourism industry was one of the three main contributors to growth in the region in 2006, following continuing expansion in recent years. Strong growth in the region's main source markets, coupled with domestic efforts to improve the attractiveness of destinations, marketing, and air access, led to the continuing growth in industry performance. At the same time it should be noted that increased visitor expenditure was an important element in industry growth, since overall expansion in the number of arrivals was relatively modest, and since cruise visitor arrivals declined in many jurisdictions. With respect to long-stay arrivals, available source market data for 12 BMCs, suggest that while all markets performed well, the US and the Canadian markets were exceptional, with only one country registering a decline in visitors from both markets. The outturn from Europe was mixed, however, with 7 recording growth and 5 showing declines. Cruise Tourism performance continued to be adversely affected by a number of factors including high fuel costs, resulting in changes in cruise routes and a dampening of the industry segment's performance during the year. AgricultureThere was some improvement in agricultural sector performance in 2006, largely reflected favourable weather following the adverse conditions of the previous two years. In addition, there appeared to be greater public sector involvement in 2006 through the implementation of projects designed to improve competitiveness and agricultural support services. Enhancements to agricultural infrastructure through better drainage and irrigation, and modernisation to existing facilities along with improvements in husbandry practices and seed quality also contributed to the improved performance during the year. The prospects for sugarcane, however, remained uncertain, with traditional sugar production facing worsening export price prospects as a result of import regime changes in Europe, while domestic efforts to utilise sugarcane in alternative ways, calculated to increase final value-added, continued. ConstructionRegional Construction activity remained buoyant in 2006 as public and private sector projects proceeded apace. Preparations for the Cricket World Cup competition provided a considerable part of the impetus for activity during the year, although high levels of activity could also be traced to residential demand and to non-cricket-related business and tour ism demand. Hotel, condominium and villa Construction dominated activity in the private sector, while, in the public sector, work included, but was not restricted to, improvements to road infrastructure, air- and sea-ports enhancement, and refurbishment of sports stadia. Other public sector work included expanding the housing stock, hospital services, flood mitigation activities, and improving arrangements for the delivery of general government services to the public. The sector experienced difficulty from time to time during the year as a result of cement supply inadequacies.ManufacturingThere was some output growth in the manufacturing sector in the region during the year, although the sector continued to provide major contributions to output, employment and incomes only in the major economies and in the larger countries of the region. This growth which occurred was fuelled by increased regional and international demand, with domestic demand in some countries being encouraged by "buy-local" campaigns, and by other forms of public sector support. In particular, there appeared to be some increased market penetration in the US, particularly for petrochemicals, electronic components, data services and high-end wooden products. Mining and QuarryingAvailable data suggests that regional mineral production showed some improvement in 2006. In Guyana, sector output continued to show the effects of the closure of a large gold producer, consequent on the completion of ore extraction from its main mining sites. However, product declarations from small and medium sized firms suggest an expansion in their operations, fuelled by rising prices. The bauxite industry fared better, showing signs of growth in both Jamaica and Guyana on account of favourable international demand. In Guyana this occurred at a slower pace than in 2005, as a fall in prices led to the closure of a major producer of calcined bauxite. This was partially offset, however, by increases in the production of chemical grade and metal grade bauxite as another major player entered the market. Production of alumina in Jamaica, is also likely to have increased, though marginally as industrial unrest adversely affect output. In Trinidad and Tobago, the energy sector continued its rapid expansion, spurred on high oil prices and ongoing exploration. Growth in this sector has been mainly attributable to strong performances in the exploration and production, refining and petrochemical sub-sectors. Small quantities of oil were discovered in Belize, and production for export to the US commenced during the year.Offshore Business ServicesIndications are that the regional international business and financial services sector continued to build on past gains and expanded further in 2006, as evidenced by a rise in the number of licenses and an increase in registration fees. While this would have reflected the favourable external environment, efforts at the local level to enhance the attractiveness of the jurisdiction also contributed to the overall outturn. During the year, work continued on improvements to the region's legislative regime with the passage of new legislation and refinements to its regulatory structure. There was also some evidence of product diversification and consolidation in the sector, with the establishment of new investment vehicles such as SMART funds in the Bahamas, and mergers particularly in the areas of banking and trust companies, which offered new scope to realise operational efficiencies.ProspectsThe outlook for regional economies appears to be very favourable in 2007. Tourism activity is expected to benefit greatly from the hosting of Cricket World Cup competition in the first half of the year. While Construction sector activity is projected to slow somewhat as a number of related cric ket investment projects are completed, other public and private sector projects currently underway or about to commence will fill the slack in the short- to medium-term; and the expected marketing benefits should drive visitor arrivals. There are areas of risk, however. While Tourism has become the major income, employment and growth driver in the region, many BMCs have in effect substituted a past dependence on a single industry, sugar or bananas, for a new one, Tourism. The consequences of Tourism dependence were evident in the immediate aftermath of 9/11, and, more particularly, during the months preceding the terrorist attack when the US economy contracted and some Caribbean governments thought it necessary to provide special assistance to the industry. Secondly, the industry is extremely sensitive to the quality of environmental management; and it is not always clear that environmental issues, and the associated disaster management issues, are being given the attention that is commensurate with the contribution of the industry to the economic and social well-being of countries.Perhaps even more critical are the increasing signs of social instability, evident in the steady rise in the incidence of violent crime across the region; in an increasing disaffection, particularly among male youth, with education; in decreasing levels of tolerance and courtesy; and in increasing unwillingness to seek excellence in work performance. While there is a clear link between innovation and problem-solving, on the one hand, and freedom to explore and to imagine, on the other, there is an increasing need for institutional arrangements to stimulate and motivate creativity in our societies, and to channel the resulting social energies into pathways which are productive.The agricultural and manufacturing sectors will continue to be challenged by competitiveness and productivity issues, particularly as trade liberalisation and globalisation processes evolve. The improved competitiveness and production flexibility that is sought for these and other sectors will be achieved through the industry restructuring that is a critical part of the economic transformation to be attained through the two currently ongoing regional integration processes, one affecting the OECS subregion, the other affecting the wider CARICOM region. Significant effort will be required to ensure that the benefits in fact flow from integration; and a great deal of care will be required from the OECS countries and from the wider CARICOM grouping to ensure that the two sets of initiatives do not develop into areas of conflict for each other. Focused attention to fiscal and debt management will be critical, particularly given the economic and social adjustments that will need to be made, and at a faster pace than that to which we have traditionally been accustomed. Regional decision-makers, however, are well-aware of the issues, and it is out expectation that the opportunity provided by the current level of economic performance will be seized, and that the appropriate decisions will be taken and expeditiously implemented. Part B - CDB'S Performance in 2006Several of the Bank's borrowing member countries began the year troubled by excessive public debt and large fiscal deficits. By the end of the year, it was clear that they had embarked on significant fiscal reforms and debt adjustment programmes with consequential improvements in fiscal capacity, public expenditure management and reduction of debt service burden. CDB was very engaged in this process of regaining fiscal stability and improved debt management. In addition to technical assistance provided in relation to improvement of fiscal revenue systems and its encouragement of return to the practice of public sector investment programmes, the Bank introduced two new financial instruments to assist countries. One is policy-based loans (PBL) which were provided to Belize (USD25 million (mn)) and St. Kitts and Nevis (USD20 mn). The PBL is intended to provide budgetary support within an agreed programme for macroeconomic and fiscal reform. The other instrument is a Policy-Based Guarantee provided in this first instance to St. Kitts and Nevis (USD8.2 mn) to enable restructuring of its foreign debt to lower cost options.Overall, CDB approved new loans, grants and equity contributions totalling USD128.6 mn in 2006 and also approved a USD8.2 mn loan guarantee for St. Kitts and Nevis. Disbursements over the same period amounted to USD131.9 mn. Sixty-two percent of the new approvals were to the Bank's LDCs, that is Belize, and the Organisation of Eastern Caribbean States (OECS) members; twenty-seven percent went to the MDCs; and the remaining eleven percent went to regional projects.In terms of areas financed, resources were approved for financial sector modernisation in Barbados (USD3.5 mn); Tourism and business infrastructure (Jamaica's Norman Manley International Airport (USD11 mn), Barbados' Harrison Cave (USD 16.9 mn), Grenada's Grenville Market Square (USD11 mn); education and human resource development, notably the University of the West Indies (UWI) Cave Hill School of Business (USD3.5 mn) and the UWI Institutional Consultancy Company (USD150,000); electrical energy supply in Nevis (USD8.4 mn); and national planning capacity in Jamaica (USD1.7 mn); The Bank also financed disaster risk reduction through the development of Caribbean Uniform Building Codes (USD1.4 mn); and health through support for a Feasibility Study of a Regional Health Insurance Mechanism (USD270,000). Additionally, a line of credit for USD7.0 mn was provided to the Turks and Caicos Islands.Being very conscious of the fiscal pressures on its BMCs in a situation of unsatisfied demand for development finance, the Bank endeavoured to avoid any substantial increases in its loan rates of interest despite the global trend towards higher interest rates and a rise in the Bank's own borrowing costs. To this end, the Bank introduced a new Capital Adequacy Framework for financial risk management and loan pricing.An important development which culminated in January 2007, was the completion of formalities for admission of the Republic of Haiti among the Bank's BMCs. We hope that this will encourage Suriname, the only CARICOM country that is not yet a member, to complete the process for its own admission to the ranks of CDB BMCs.Finally, CDB maintained its active participation in the regional economic integration process, hosting meetings of the Council for Finance and Planning and other committee meetings, and spearheading the work for the establishment of the CARICOM Development Fund.