Economy of Puerto Rico – June 2009

July 30, 2009

The economy of Puerto Rico continued to show signs of deterioration during the first three months of 2009. The contraction in the economy has now gone on for 12 consecutive quarters, and in the first quarter of 2009 a drop of 2.7% was recorded, which appears to be the sharpest decline in the entire period. All major economic indicators have been adversely affected in the last few months, with significant declines in the manufacturing, construction, tourism, commercial banking, and retail sales sectors. Of particular importance is the deterioration in government finances and the labor market. In March 2009 the unemployment rate reached 14.7%, the highest since June 1996, when it rose to 15.6%.

Oil and gas prices have not been determining factors in this scenario, since both fell slightly at the beginning of the year. However, the recession in the U.S. intensified in the first quarter of 2009, with a decline in the Gross Domestic Product of 5.5%, and this slowdown has unquestionably adverse effects on local economic activity. The manufacturing sector, which performance is highly susceptible to drastic changes in the U. S. economy, seems to be among the worst hit. Given that the United States is the principal market for Puerto Rican exports, economic weakness on the continent has a major impact on the island. It can be seen in the declining jobs trend observed in the sector, as well as cutbacks in average hours worked and in payroll, which fell some 3.8% in the first quarter of 2009. Exports declined 10% in this period ($1,632 million), which represents a substantial blow to the GNP over the first three months of the year.

The contraction of total employment demonstrates that manufacturing activity was not the only indicator severely affected in the first few months of the year. During the first quarter of 2009, both total employment and the participation rate turned in the lowest numbers recorded in the last seven and a half years. The loss of jobs was notable in all sectors, with the exception of the public sector, which, according to the federal Labor Department’s Office of Labor Statistics, recorded a year-to-year increase of 3,400 jobs as of March of 2009, while total jobs fell by 109,000 in comparison with the same month a year earlier.

Due to much the same reasons as in the manufacturing sector, tourist activity, which depends mainly on visitors from the mainland United States, has taken a direct hit from the recession. In the first three months of 2009, substantial declines have been recorded in hotel registrations of all kinds (-9.2%).  Tourist hotels recorded a drop of 8%; “paradores”, 20.3%; and commercial hotels, 15.5%.  The island’s hotel facilities are experiencing relatively low occupancy rates (65.8%), as well as an average length of stay shorter than normal.

The construction sector has been undergoing a severe decline for some time, and at the beginning of the year it recorded yet another substantial loss. Indicators such as the value of permits granted, construction of new housing units, cement sales, and jobs in the sector show that this industry has not yet begun to recover from the adverse effects associated with the recessionary cycle, even though the cost of financing has fallen and government subsidies have been offered as an incentive to investment. The restrictive credit policies adopted by banks have been another factor slowing the sector’s recovery. In January 2009, the total value of permits granted recorded a year-to-year decline of 46.1%.

Another indicator that illustrates the fragility of the local economy is commercial activity. In the first few months of 2009, retail sales have shown a downward tendency consistent with decreases in sales and service tax (IVU) collections during the first quarter of the year. Sales have been falling at a rate of about 2% a month, although prices have remained stable. Thus, it would appear that the downturn in consumer spending is associated with low consumer confidence in the face of the financial uncertainty that has prevailed throughout this recessionary cycle.

The performance of the U. S. economy, as well as implementation of new fiscal and budget policies in Puerto Rico, will to a large extent determine the performance of the local economy over the next few months. It remains to be seen whether the measures now being proposed and the federal government’s economic stimulus will be enough to bridge the budget gap projected for this fiscal year.

Government Revenues
Income to the government of Puerto Rico fell below estimates during the first nine months of fiscal year 2008-09, and was some $260 million below the income reported for the same period in 2007-08. This drop-off in government revenues was recorded after the island Treasury Department revised previous estimates downward at the beginning of the year in the wake of the Planning Board’s forecast of a 3.4% decline in the Gross National Product. The government’s net income decreased by about 4.9%, affected mainly by a decline of 5.2% in income tax collections, down about $195 million over this period. Income from IVU collections fell by $35.4 million (5.4%), while a decrease of 4.3% was also recorded in excise taxes, affected mainly by a decline in motor vehicle taxes, down 11% over this period.

The decrease in government revenues was notable in the first quarter of 2009, when net income to the General Fund reached $1.757 billion, some $76 million (4.6%) less than for the same period a year earlier. All categories of income declined. Income tax fell 47% and the IVU fell by $7.2 million (2.7%) as a consequence of the pullback in consumer spending.

This decrease in government revenues exacerbate the liquidity problem faced by the government and suggests that the economic contraction may both broaden and last longer than desired. The Treasury Department estimates that at the end of the current fiscal year, total income should be close to $7.7 billion, which would be $1.1 billion less than a year earlier and $1.8 billion less than the current budget ($9.5 billion). Given this situation, the government has asked the Government Development Bank for a loan of $2.5 billion, which should serve to pay benefits to employees dismissed from government service ($1 billion), establish an Economic Stimulus Program ($500 million), and pay debts and operating expenses ($1 billion). Thus, the 2009-10 budget is close to $10.2 billion, but 25% of those funds are non-recurrent, which raises the specter of increased difficulties in fiscal year 2010-11.

BPPR Indexes of Economic Activity
The BPPR-IREA and INEA both suggest that the Puerto Rican economy continues to experience a significant contraction in levels of economic activity. The value of the indexes shows an economy in recession since early 2006, which has apparently deepened over the first few months of 2009.

The seasonally adjusted BPPR-IREA recorded a value of 117.0 points for the first quarter 2009, a decline of 2.7% in comparison to the first quarter of 2008. This is the largest year-to-year quarterly contraction in the history of this index, which contains data since the first quarter of 1990. The BPPR-IREA also showed a decrease of 0.7% over the previous quarter.

This decline in levels of economic activity is consistent with the deterioration in all the index’s components, which reflect the poor performance of the construction sector and tourism during the first few months of the year. Large decreases were recorded in cement sales, electric energy consumption, and hotel registrations, which in turn triggered a further decrease in tourism employment.

The BPPR-INEA recorded an average value of 209.9 points in February 2009, a decrease of 2.7% in comparison to February 2008, which is the largest year-to-year decline since March of 2007. This decrease was triggered by a drop in three of the five components of the Index: manufacturing payroll, imports, and jewelry store sales. In the first eight months of fiscal year 2008-09, the BPPR-INEA recorded an average value of 212.5 points, showing zero growth in comparison to the average value recorded for the same period during the last fiscal year.