HIGHLIGHTS OF CDB'S ACTIVITIES IN 2005 AND ECONOMIC BACKGROUND AND PROSPECTSPart A - Regional Economic DevelopmentsOverviewPreliminary indications are that while GDP growth continued in most of CDB's Borrowing Member Countries (BMCs) in 2005, the pace of that growth slowed somewhat, mainly in response to a deceleration in Tourism activity, and a decline in agricultural production. On the other hand, activity in the Construction sector rose strongly across the region, since, in addition to on-going public and private investment and the current boom in residential Construction, work continued on re-constructing and re-habilitating assets damaged by hurricanes in 2004 and 2005, and preparations for Cricket World Cup 2007 intensified. The increase in output, along with efforts to improve the efficiency and effectiveness of the management of the public finances, also resulted in a rise in government revenue collections. Some administrations moved to tighten monetary policy, mainly through an increase in interest rates, to counter continued strong expansion in private sector borrowing and its resultant pressure on foreign reserves, following a period of relaxation, beginning in late 2001, to counter the downturn in activity which came in the aftermath of the September 2001 terrorist attacks in the US. The policy tightening also reflected increasing concern over the likely effects of the sharp rise in oil prices early in the year, and the maintenance of high oil price levels throughout the rest of the year. The combination of factors would have led to a general upward movement in prices and to a decline in foreign exchange holdings across the region, with unemployment rates trending downwards.On the institutional front, the offer of long-term development credits on a government to government basis by Venezuela tied to the purchase price of petroleum from that country encouraged some re-examination of the existing regional trading arrangements for petroleum products. More generally in the region, significant effort was focused on meeting the December 2005 deadline for putting arrangements in place for the start of the single market component of the CARICOM Single Market and Economy (CSME).Social sector issues continued to occupy the attention of the authorities, with violent crime and drug trafficking continuing to make the headlines. There were increasing reports of work stoppages and strikes, particularly in the Construction sector, although these were all of short duration, and were probably related to relatively tight labour market conditions in that sector.Sectoral PerformanceReal OutputReal GDP growth in CDB's BMCs taken as a group is estimated to have slowed in 2005 compared with 2004, as a result of a slowdown in Tourism and some contraction of output in agriculture. The surge in Construction activity during the year, however, provided a substantial offset, and the level of economic activity was higher in some countries during 2005 than in the previous year. Preliminary data suggest an overall decline in output only in Guyana, where unseasonably wet conditions and major flooding caused significant disruption, and in Montserrat, where the completion of a new airport facility led to a sharp decline in Construction sector activity. The on-going shift towards services-based activity continued, with strong growth in wireless telecommunications at both the personal (cell-phone) level and in business operations, as emphasis was placed on improving and expanding business networks and in increasing bandwidth for both business firms and households. The number of internet subscribers continued to grow rapidly, and with that, the number of business firms and government agencies providing internet access for business and financial transactions. Much of the expansion in economic activity was financed by increased lending by financial institutions, particularly commercial banks. These institutions had accumulated a substantial level of excess liquidity during previous years. In recent times, decreased levels of public sector borrowing, as governments restrained their direct borrowing in the face of high debt levels, and increasing competition from non-bank institutions encouraged banks to embark on an aggressive credit expansion campaign, focusing on home-mortgage lending and on consumer credit through the use of credit cards. The resulting expansion in consumer credit contributed to a sharp rise in the value of imports, which was exacerbated by significant increases in the import cost of petroleum products. These developments, together with on-going public and private investment, as mentioned earlier, placed increased pressure on the balance of payments. One implication of this is that the impetus for further substantial growth in the medium term will have to come from external sources.TourismFollowing strong growth in the previous year, the performance of the Tourism industry in the region slowed in 2005. Damage to hotel accommodation in Grenada and in the Cayman Islands caused by Hurricane Ivan in 2004 was responsible for the sharp declines (36% and 41%, respectively) in the number of long-stay visitors to those countries during the year, although reConstruction and rehabilitation work continued apace. In others (except Antigua and Barbuda where the 4% decline partly reflected hotel closures for renovation) the decline in long-stay arrivals was marginal. The larger share of the decline in visitor arrivals occurred in the cruise-passenger segment of the market, and appeared to have reflected repositioning of cruise ships and changes in cruise routes in response to market shifts and sharp increases in fuel prices. Only Cayman Islands, Grenada and Jamaica recorded increases in cruise-passenger arrivals, although the picture was slightly complicated because of the large proportion of day-visitors by sea to Anguilla. ConstructionThere was an increased level of activity in the Construction sector in 2005 compared with 2004, reflecting increased investment by both the public and private sectors. Hurricane-related re-building of public and private structures, which got underway fully during 2005, and preparations for the Cricket World Cup competition in 2007 accounted for a significant part of the growth. In the public sector, these preparations included the rebuilding and refurbishing of stadia with accompanying improvements to supporting infrastructure, including roads an d urban centres; while activity in the private sector focussed on improving and expanding accommodation and entertainment facilities. In addition, public and private sector investment activities continued, involving substantial work on roads, public and private housing development, and on ports, with these operations contributing to some tightening in the supply of skilled labour and in the supply of materials, in particular cement. Agriculture and ManufacturingOutput in the region's agricultural and small non-mineral manufacturing sectors declined in 2005, mainly on account of adverse weather conditions in both 2004 and 2005. Production of sugar and bananas, the region's main export crops, as well as output of non-traditional crops, contracted. With respect to sugar, only Barbados showed growth, as production declined in Belize, Trinidad and Tobago, Jamaica and Guyana, while St. Kitts and Nevis closed its sugar-producing operations as part of its economic restructuring programme. In addition to the unfavourable conditions which included dry weather conditions in Belize and Jamaica, and excessive rainfall in Trinidad and Tobago and Guyana, sugar manufacturing output was also adversely affected by a high incidence of canefires and reduced acreage under cultivation. In consequence, regional sugar production declined by approximately 22% following a 1.9% rise in 2004. Banana production declined as a result of adverse climatic conditions, and reflecting the increasingly uncertain future facing the industry. During the first nine months of the year, output in Jamaica and Belize decreased by 70.7% and 6.5%, respectively, while annual data for the OECS showed declines in all the banana producing economies, with output falling by 25.7%. In Grenada, which is no longer a significant banana exporter, the passage of hurricane Ivan in 2004 destroyed existing banana plantings; while in St. Lucia, cash flow difficulties and leaf spot disease exacerbated unfavourable climatic conditions. Manufacturing sector output rose in Trinidad and Tobago, partly in response to rising demand from the rest of the region; while output rose slightly in the enclave sector in St Kitts and Nevis in response to demand from the US. Some expansion in manufacturing occurred in Barbados, partly as a result of strong marketing effort and support from the public sector.Other ServicesThe financial services sector is estimated to have expanded in 2005, based on the higher number of registrations and licensing fees, particularly from international business companies. The stable macroeconomic and political climate, as well as the region's efforts to improve the legislative and regulatory environment to reduce money laundering and related criminal activity generally impacted positively on the performance of the main offshore business jurisdictions. In addition, there was further diversification within the sector in 2005 as Anguilla began activities in the mutual funds and captive insurance industries; and the insurance sub-sector in the Cayman Islands benefitted from higher insurance premia following the 9/11 events. The BVI continued to benefit from the success of its international road shows.As indicated earlier, financial sector activity expanded during the year, as commercial banks and non-bank institutions sought to expand their business operations and individual market shares. There was significant expansion in lending, and excess liquidity levels declined. With much of the credit expansion engaged initially in the financing of non-tradeable items, the expansion in credit was reflected in some decline in the level of international reserves, and this prompted some corrective action in some jurisdictions.Activity in the area of transport and communications was mixed. As indicated earlier, there was subst antial expansion in telecommunications and related information processing operations, as both capacity and the use of that capacity continued to expand in both the private and public sectors. Sea transportation expanded, with the provision of faster service between Trinidad and Tobago, and with increasing use of ferry services in the northern Windward Islands. On land, public sector programmes to expand and improve road networks to accommodate a rapidly increasing motor vehicle population continued, although there was increasing concern that some effort ought to be directed towards providing or improving mass transit services, as an alternative to expensive road Construction. Air transportation arrangements within the region continued to be a source of concern, given the dependence on the region on Tourism and on air transport, with all the main carriers in the region reporting substantial operating losses. This outturn carries with it a continuing threat of closure of operations. So far, efforts to restructure the regional air transport industry into a financially viable operation have not been successful.Mining and QuarryingThe mining and quarrying sector showed some performance improvement in 2005, with output rising in Trinidad and Tobago, and Jamaica, but falling in Guyana. In Trinidad and Tobago, the energy sector continued to benefit from high oil and petrochemical prices and from past expansion in productive capacity. Within this sector, output in the exploration and production, refining, and petrochemicals sub-sectors rose by 9.2%, 10% and 27.4%, respectively. In Jamaica, bauxite production rose 10.3% during the first ten months of the year, while output of alumina grew by 3.2%. In Guyana, however, the mining and quarrying sector contracted by 17.3%, reflecting lower diamond and gold declarations, with gold production being adversely affected by the closure of a major mining company. Bauxite production in Guyana is estimated to have increased by 13.5%, as the entry of a large operator boosted output during the year. Public Finances and DebtThe region continued to struggle with public debt and public finances management during the year. While there has been full recognition across the region of the difficulties which have been caused by past approaches to public finances management, while substantial effort is now underway with the help of the region's development partners including CDB and CARTAC to address those difficulties, the problems are serious, and their solution will require strong and sustained effort by the authorities in each country. CDB is continuing to work with countries to address their difficulties, and has positioned itself to provide much more assistance than it had been able to provide in the past.ProspectsThe prospects for 2006 are reasonably favourable, driven largely by Construction in anticipation of continued growth in Tourism. As preparations for the 2007 world cup cricket competition gather momentum it is likely that there will be further acceleration in Construction activity. This will require attention to be paid to existing supply bottlenecks. Tourism activity should benefit from a favourable global environment, continued improvements to marketing initiatives and additions to hotel-room stock. With respect to traditional agriculture, the future of sugar and bananas in most jurisdictions is not favourable; and more effort is needed to identify and develop substitute products, preferably as specialty and niche market items. These developments may place further pressure on the external account, particularly if oil prices rise further. Demands on public revenues are also expected to increase in the near term, on account of higher recurrent expenditures, support for infrastructural development and accelerated preparations for World Cup 2007. The effort to create a single market and economy in the region should, if successful, help the region to develop globally competitive products, and to develop and maintain production flexibility in the face of continuing changes in the global environment. Success requires that the integration of production and associated arrangements be pursued to its fullest extent, and that the inevitable difficulties which will occur be viewed as challenges to be overcome rather than obstacles to prevent the achievement of the objective. Much good work has been done, even more remains to be done. CDB intends to deliver fully in order to help realise the region's objectives. Part B - CDB'S Performance in 2005In several respects, 2005 was a successful year for the Caribbean Development Bank. Strong positive responses were made to the quite severe economic difficulties experienced by borrowing member countries (BMCs), especially those affected by hurricanes, tropical storms, floods and landslides.New loans and grants totalled USD 153 million (mn) approximately, in 2005, a 24 percent increase on the USD 124 mn approved in 2004. The Bank also had a good disbursement performance, disbursing USD 143 mn in 2005. Consistent with its Charter obligations and the practice in every year, the Bank paid special attention to the less developed countries, disbursing USD 61 mn (43%) of the total resources to the OECS countries and USD 9 mn (6%) to Belize. Among the OECS countries, the main beneficiaries were St. Lucia (USD 20 mn), Grenada (USD 14 mn) and St. Vincent and the Grenadines (USD 8 mn).Financing physical infrastructure for socio-economic development comprised most of new lending in 2005. Among these were highway and road development projects in Dominica, Grenada, Jamaica and St. Lucia, and power generation projects in Anguilla and Belize. The power generation project in Belize is particularly notable because it is a renewable energy project which utilises sugar cane bagasse. A total of USD 108 mn was approved for physical infrastructure projects.Social infrastructure and support for training and knowledge creation and dissemination claimed proportionately more of grant resources. Grant financing was approved for enhancement of community services such as basic schools and primary schools, day care centres, health care centres, water supply and skills training in Belize, Dominica, Grenada, Guyana, Jamaica, St. Kitts and Nevis, St. Lucia and St. Vincent and the Grenadines. The Basic Needs Trust Fund which is the Bank's flagship direct poverty reduction programme through which the grants are provided had a remarkably successful year approving USD 12 mn for 158 projects and disbursing USD 6 mn. The Bank supported regional workshops on several subjects including early childhood development, the financing of tertiary education, small enterprise development, social work education, integrated water resource management and the creation of a sustainable framework for monitoring the Millennium Development Goals.Of necessity, the Bank devoted considerable attention to emergency relief and economic and social rehabilitation in countries severely affected by natural disasters. Grenada continued to be the main recipient of financial assistance with loans for economic reConstruction, low income housing and disaster mitigation. Guyana was assisted in coping with its disastrous floods. Through its Disaster Mitigation Facility for the Caribbean, CDB intensified its education, training and policy adoption activities for disaster risk reduction and risk management. Grant resources were directed towards improving comprehensive disaster management databases, revising regional building codes, the development and delivery of an introductory course in natural hazard management and a workshop on vulnerability assessment and techni ques, and the publication of a volcanic hazard atlas of the Lesser Antilles.Improvements in public governance and economic management are a central objective of CDB. To this end, projects valued at USD 4.5 mn were approved, including the reintroduction of a training programme in project planning and project management for the benefit of public officials.Support for Caribbean economic integration continued in 2005 with financial contributions to the Caribbean Regional Negotiating Machinery, the Caribbean Commission on Health and Development, the Caribbean Regional Technical Assistance Centre (CARTAC), and with the Bank's technical and financial support for the establishment of the Regional Development Fund.Several other noteworthy developments during 2005 are the successful replenishment of the Special Development Fund in the amount of USD 156 mn; the completion of a Euro 40 mn loan agreement with the European Investment Bank for the financing of small and medium-sized enterprises and national projects; and the approval of the policy-based lending instrument which would facilitate financial support for policy reforms and institutional changes in BMCs.