January 28, 2010 No. 1/10 - G HIGHLIGHTS OF CDB'S ACTIVITIES IN 2009 AND ECONOMIC BACKGROUND AND PROSPECTS PART A - ECONOMIC REVIEW AND PROSPECTS 1. International Economic Developments Global economic activity is estimated to have contracted by approximately 1% in 2009, reflecting the impact of the global financial crisis and the contraction in global trade. The decline was led by a significant fall in economic activity in advanced economies, and transmitted to emerging economies mainly through trade and foreign direct investment (FDI) channels. However, signs emerged that global economic activity started to recover in the second and third quarters. Underpinning this recovery was an improvement in consumer and business confidence, which in turn was boosted by the aggressive monetary and fiscal policies put in place in response to the crisis. The United States (US) economy suffered extensively from the financial strains and the housing sector decline, but started to pick up in the third quarter. The recovery largely reflected rebounds in consumer spending, residential investment and exports, as government stimulus measures boosted private demand, particularly in the automotive and housing sectors. Apart from problems in their financial sectors, other advanced economies were also affected by the deceleration in global trade. Like the US economy, the Japanese economy accelerated in the third quarter, driven by business investment, consumer spending and exports and supported by a fiscal stimulus package. In the European Union (EU) the economic situation also appeared to be on the mend, with growth in some countries and a moderation in the rate of decline in others. Growth in emerging Asian economies remained positive, but fell to around 5% in 2009. Among these economies, China was the fastest growing, with real Gross Domestic Product (GDP) increasing by 8.5%, while India's GDP grew by 5.4%. Overall, economic activity in these economies was affected by the abrupt global downturn, but rebounded towards the middle of the year aided by expansionary monetary and fiscal policies. These policy changes, as well as the return of substantial capital inflows, boosted investment in fixed assets and helped create employment. In Latin America, economic activity fell during the first quarter of 2009 as a result of tighter external capital markets, a decline in export demand, deterioration in terms-of-trade, and a fall in workers' remittances. By the second quarter, there were signs that economic activity was gradually recovering from the global downturn due to domestic stimulus measures and rising commodity prices, as well as positive stock market wealth effects. However, the recovery in emerging markets has largely reflected improved domestic demand, as still weak external demand has weighed heavily on these countries' export performances. Amid the recovery, inflation has remained low, with deflation even being recorded in some months, due to commodity price effects, as well as reduced demand. However, towards year-end there was an uptick in inflation rates as oil prices rebounded. Looking ahead, the global economy is expected to continue its gradual recovery in 2010, supported by the current low interest rate environment and expansionary fiscal stances on the part of the major economies. However, the sustainability of the recovery is contingent on certain factors, including the extent to which oil prices continue to rise and weak labour market conditions persist, as well as the timing and pace of the eventual unwinding of the macroeconomic stimuli and correction of global imbalances. II. Regional Economic Developments Overview Preliminary estimates indicate that economic output contracted in most regional economies in 2009, reflecting the lagged impact of the global financial crisis and economic recession. Indications are that only four Borrowing Member Countries (BMCs) recorded positive GDP growth in 2009 - Belize, Guyana, Haiti and Montserrat. Among the other BMCs, real GDP in Anguilla contracted by more than a quarter, after a prolonged period of high Construction-led growth that was fuelled by FDI. Antigua and Barbuda and Cayman Islands recorded declines that were in excess of 5%, while the real output contraction among most of the remaining BMCs was between 1 and 4%. The main transmission channels of the crisis to regional economies were sharply declining tourist arrivals and a fall-off in FDI, which negatively affected investment in Tourism-related Construction projects, reducing output and employment in both the Tourism and Construction sectors. In addition, the financial crisis adversely affected offshore sector activity in all major jurisdictions and threatened the soundness and stability of regional financial sectors. In the face of these exogenous shocks, Belize and Guyana have shown some resilience. However, the majority of regional economies are highly dependent on Tourism and other services and have therefore proved to be much more vulnerable. The associated impacts have been so adverse that these economies have had to seek external financing to mitigate the effects on foreign exchange reserves and liquidity levels in the banking system, as well as to improve fiscal and debt sustainability. However, with credit ratings reflecting these impacts and global financing conditions remaining tight, countries have tapped the regional capital market and various financing facilities offered by the Multilateral Finance Institutions (MFIs) including the Caribbean Development Bank (CDB). In addition, some countries have turned to non-traditional sources of financing for similar macroeconomic support, as well as for grant resources to finance development efforts. Poised to become an additional source of development finance for the Region, the CARICOM Development Fund commenced operations on August 24th, 2009, marking a critical milestone in the regional integration process. Real SectorTourism Generally, stay-over arrivals declined across the Region, with double-digit falls being posted by most destinations amid weak source market demand and reduced airlift. This was also reflected in significantly lower visitor expenditure. Conversely, cruise passenger arrivals have remained buoyant, with several countries reporting increases in excess of 15%. However, since stay-over arrivals typically account for the majority of visitor spending, the net effect on Tourism value added of these divergent trends has been negative. This divergence appears to be a continuation of a substitution effect that has been observed in recent years. Tourists are increasingly opting for the cruiseship over the stay-over format, apparently based on the perception that it offers better value for money - a factor that is even more critical in the context of the global downturn. Jamaica has been the only major Tourism destination to buck the regional trend: increased stay-over arrivals in that country have been attributed to the diversion of tourists away from Mexico due to the Influenza AH1N1 virus outbreak, as well as aggressive marketing and discounting. On the whole, arrivals from Canada increased, and most of these travelled to Jamaica. However, with the US and Europe being larger source markets, the impact of declines in stay-over arrivals from these markets dominated sector trends. Construction The slump in Construction activity that began in 2008 continued into 2009 due to persistent weakness in FDI inflows for Tourism-related projects, which had underpinned Construction and overall growth during the lead-up to and hosting of Cricket World Cup (CWC) in 2007. The effects of the fall-off in FDI on private sector-led Construction activity was exacerbated in some countries by reductions in public sector spending on capital projects due to limited fiscal space. Even though some governments were able to finance accelerated capital works programmes through grant inflows, e.g. Dominica, Construction activity still declined sharply. The main exceptions were Guyana and Belize, where Construction activity was a key factor in those countries recording overall economic growth, albeit at a reduced pace. Manufacturing The crisis had a negative impact on the regional manufacturing sector, both directly - through the reduction in global import demand and tight financing conditions - and indirectly, as the declines in Construction and Tourism reduced demand for foods, Construction materials, and other manufactured goods produced in the Region. Mining and Quarrying Increases in petroleum output were recorded in Trinidad and Tobago, and Belize, boosted by a modest recovery in petroleum prices from end-2008 lows. In contrast, bauxite output contracted sharply in Jamaica and Guyana, due to the closure of two large producers (ALPART and WINDALCO) in Jamaica and the slump in global demand. Conversely, gold declarations in Guyana rose owing to higher global demand for this commodity, in line with its safe-haven status. Agriculture The major agricultural producers recorded mixed performances during the year. Jamaica and Grenada recorded strong growth, reflecting a recovery in agricultural output after hurricanes Gustav and Ivan, respectively. Conversely, agricultural output in Dominica fell as a result of a steep drop in banana production. Belize and Guyana also posted significant contractions, driven by a fall-off in citrus production in Belize, related to flood damage in 2008; and poor sugar and rice harvests in Guyana due to higher than expected rainfall. In general, sugar and banana production continued to decline across the Region, reflecting weather-related and other country-specific problems, as well as the ongoing effects of trade preference erosion. Employment Available data and anecdotal evidence from around the Region indicate that the downturn in economic activity has been reflected in rising unemployment in most countries, particularly in the hard-hit Tourism and Construction sectors.Inflation Inflationary pressures in the Region subsided during 2009 from 2008 peaks, largely reflecting the fall-off in aggregate demand due to the crisis and the generalised reduction in international food and petroleum prices observed since the latter half of 2008. In fact, several regional economies have been experiencing deflation. However, those countries for which data is available past August (that is, The Bahamas, Jamaica, and Trinidad and Tobago) are showing signs of renewed inflationary pressures consistent with recent upticks in international commodity prices. External SectorBalance of Payments Foreign exchange earnings from exports of goods and services generally declined, as the Tourism sector downturn translated into reduced travel receipts, while lower commodity prices (with the notable exceptions of gold and diamonds) affected the value of primary-good exports. In addition, some regional economies reported significantly reduced inflows of remittances. However, current account balances generally improved due to falling import values related to reductions in both import demand and international commodity prices. Nevertheless, overall balance of payments (BOP) positions were generally negative or less positive due to a fall-off in FDI inflows, with a concomitant adverse impact on foreign exchange reserves. However, the effect on reserves was mitigated somewhat by the International Monetary Fund's (IMF) decision to boost all member countries' Special Drawing Rights allocations in August and September. Exchange Rates Guyana, Jamaica, and Trinidad and Tobago, the three regional economies with floating rate regimes, all maintained relative exchange rate stability despite slight depreciations against the US dollar. The stability of Jamaica's exchange rate was based on the healthy foreign exchange position, together with the expectation of IMF assistance. In Guyana, a strong overall BOP performance accounted for continued exchange rate stability. Financial SectorMonetary Developments In the context of greater exchange rate stability and falling inflation rates, Jamaica and Trinidad and Tobago both eased monetary policy significantly in an effort to contain the adverse effects of the crisis. In Guyana, monetary policy was more focused on liquidity, which expanded as domestic credit declined and project loan inflows boosted the net foreign assets considerably. The Bank of Guyana therefore tightened monetary policy in an effort to bring liquidity back down to target levels. Elsewhere in the Region, particularly within the Organisation of Eastern Caribbean States (OECS) sub-region, monetary policy measures were generally aimed at mitigating the impact of the crisis on output and credit growth, as well as the tightening effect of the fall-off in output on deposit growth. Financial Stability and Soundness The observed tightening of liquidity was also a prudential concern. In general, following several years of improvement, prudential banking system indicators for the Region deteriorated somewhat, given the current global and regional macro-financial environment. Banks' non-performing loans rose, while capital adequacy and profitability declined. In the OECS, loan concentration remained high, especially with respect to the exposure of state-owned local banks to government. Several incidents during the year, particularly the collapse of CL Financial Group and the fraud charges brought against Allen Stanford, highlighted the magnitude of cross-country contagion risk in the Region and contributed to a flight to quality assets. These incidents have also caused further reputational damage to the regional offshore financial sector, which has been under severe international pressure in recent years, particularly from the Paris-based Organisation for Economic Cooperation and Development (OECD). In April, OECD placed several Caribbean countries on its ‘grey list' of jurisdictions that "have committed to the internationally agreed tax standard, but have not yet substantially implemented". The Cayman Islands and the British Virgin Islands subsequently graduated to the ‘white list' and at the end of the year, several other regional economies were actively engaged in efforts to sign the OECD-stipulated minimum of 12 tax information exchange agreements to show their commitment to implementing the international standards in order to graduate as well. Public SectorFiscal Performance In Guyana and Dominica, relative expenditure restraint and tax reforms resulted in higher current revenue and improved fiscal outcomes. However, public finances deteriorated in most other regional economies, largely reflecting the impact of the crisis on already-limited fiscal space. In some cases, salary increases, interest payments on accumulating debt stocks, rising transfers and subsidies, pre-election spending and/or fiscal responses to the crisis played a role in the resulting large fiscal gaps. A significant decline in revenue, especially in those countries with narrow revenue bases, was also a major contributing factor. Among the overseas dependent territories, a deterioration in fiscal performance on account of the global recession caused breaches to the fiscal rules imposed by the United Kingdom (UK) government. This in turn exposed them to heightened pressure from the UK to revise their policy frameworks towards broadening their revenue bases, with a view to improving fiscal sustainability by reducing vulnerability to external shocks. Debt/Financing Relatively robust fiscal positions in Guyana and Dominica have been supported by grant inflows, debt relief and/or concessional loans. With respect to grant inflows, Dominica and some other OECS countries have turned to non-traditional donors such as China and Venezuela for grant resources to finance development efforts. One result of the unfavourable fiscal outturns in Jamaica and Barbados has been the downgrading of these countries' credit ratings and outlooks. Such downgrades, together with the continued tightness of global financing conditions, have limited access to international capital markets somewhat. Consequently, some of the countries experiencing moderate-to-severe fiscal deterioration have sought to tap the regional capital market and several have requested financing from the MFIs for macroeconomic support, particularly in the areas of BOP, liquidity and fiscal/debt policy. The Caribbean Development Bank approved $67.8 million in support of programmes in four of its BMCs in support of their efforts at macroeconomic stability. Antigua and Barbuda also received budgetary support from the Government of Venezuela through the Bolivarian Alternative for the Americas Fund. Of the overseas dependent territories, who require explicit approval from the UK Government to contract debt, those that significantly breached UK fiscal rules have had their borrowing restricted and/or made conditional on commitment to new revenue measures. Prospects The outlook for regional economies in 2010 is largely predicated on the timing, pace and magnitude of the incipient global recovery, with recovery in the Region expected to lag behind that of the major world economies by a few quarters. In 2010, growth is expected to return to some of the economies that contracted in 2009, but the recovery of regional economies is not likely to take hold before 2011. Recovery in the major economies is particularly critical for the Tourism and Construction industries, as these are the main source markets for tourist arrivals and FDI flows. Also important for Tourism in 2010 will be the staging of several sporting events in the Region, including the International Cricket Council's 20/20 CWC. A key concern remains however, in relation to the Air Passenger Duty introduced by the UK, which will further reduce the Region's price competitiveness. With regard to agriculture, the transition to the new Economic Partnership Agreement sugar regime means the continued reduction of the guaranteed price for Caribbean sugar. The World Trade Organisation banana deal is likely to increase competition from Latin American banana exporters, although the Banana Accompanying Measures to be implemented by the EU under the Geneva Agreement on Trade in Bananas could help boost regional competitiveness. Additionally, as of January 1, 2010, Guyana will enjoy duty-free and quota-free access to the EU market for rice. Mining and quarrying in the Region should benefit from higher petroleum and metal prices, which appear to be on the rise. However, this may be offset by possible declines in bauxite and alumina production if the frequent industrial action, mechanical problems and plant closures observed in 2009 persist into 2010. Higher aggregate demand, along with any related increase in international commodity prices, may also contribute to a resurgence of inflationary pressures globally and regionally. On the BOP, the Region's import bill may rise again in line with the anticipated increase in international commodity prices, while receipts of travel credits and other export proceeds, as well as FDI, will depend on the extent of the global recovery. Prospects for the on-shore financial sector in 2010 are, in turn, mainly tied to the real-sector and BOP performances, which are expected to be lacklustre. Persistent sluggishness in credit and deposit growth is expected to continue to constrain banks' balance sheet growth. Meanwhile, the future of the offshore financial sector will be determined largely by the Region's ability to combat the reputational damage suffered in 2009 and prevent any further damage going forward, while completing the requirements for meeting OECD ‘white list' standards. On the fiscal front, the countries that saw significant deteriorations in 2009 should record some level of improvement in 2010 in the context of planned adjustment programmes. Antigua and Barbuda, Jamaica, and Grenada, in particular, are likely to undertake sizeable adjustments in the context of IMF programmes. Some of the overseas dependent territories will also be undertaking fiscal reforms in response to pressure from the UK, while ongoing reforms in the OECS, including the introduction of ad valorem taxes in some territories, should continue to yield benefits in terms of improved fiscal sustainability. In terms of the broader policy framework, the Eastern Caribbean Currency Union Eight-Point Growth and Stabilisation Plan envisages the implementation of financial programmes, fiscal reform programmes, debt management programmes, public sector investment programmes, social safety nets and financial safety nets, as well as the amalgamation of the indigenous commercial banks and the rationalisation, development and regulation of the insurance sector.The various adjustment and/or reform programmes announced in 2009 target what are seen as some of the main macroeconomic challenges facing most of the Region going forward, including structural weaknesses, large financing gaps and tenuous fiscal and debt positions. PART B - CDB'S PERFORMANCE IN 2009 Borrowing Member Countries (BMCs) of the Caribbean Development Bank (CDB) struggled in 2009 to maintain economic momentum in the face of three major problems: (i) continuing deterioration of the global economy which adversely affected demand and prices of internationally traded goods and services; (ii) further erosion of preferential market access for commodity exports; and (iii) regional financial difficulties ensuing from the collapse of a major financial conglomerate. The introduction of economic stimulus packages which increased fiscal expenditures when fiscal revenues were weakening caused a rise in fiscal deficits and government debt. These features of the overall environment in which CDB operated will be addressed in greater detail by the Director of Economics in her presentation. The CDB disbursed close to USD209 million to its BMCs during 2009. The less developed countries, including Haiti, received USD111 million and the more developed countries received USD83 million. The additional USD14 million was disbursed to regional entities. A little over USD191million in new loans and grant funds were approved by the Bank during the year. Of this total, the share of grants and highly concessionary funds was 39 per cent. Fifteen of the 17 borrowing member countries received allocations with the less developed countries as a group receiving approximately USD156 million and the more developed countries approximately USD26 million. The remaining USD10 million were approved for regional projects. The Bank's efforts to stabilize the public finances of Caribbean countries were a major feature of operations in 2009. The policy based loan and grant instrument introduced in 2007 was utilised to provide loans totaling USD68 million to Antigua and Barbuda, Grenada, and St Vincent and the Grenadines, and a grant of USD10 million to Haiti. Attached to all of these policy based loans and grants were programmes for fiscal reforms and strengthening of fiscal capacity. As would be expected, CDB continued to direct resources towards capital projects and technical assistance projects and activities in the category of social infrastructure such as education and training, business development and water supply, and in economic infrastructure such as roads. Financial support for investment in the productive sector and for government-owned financial intermediaries comprised approximately USD51 million of new approvals in 2009. We envisage on the basis of detailed, country-by-country projections that the Bank's BMCs will need to step up investment substantially over the next 5 years to restore economic growth and prevent the erosion of living standards. Given reduced access to international capital markets, they will turn increasingly to their regional Bank, CDB, for financial assistance. We have to ensure that the Bank has the financial capacity to respond positively.