The Year Ahead
García Padilla Advisers Bogged Down in Debt-Packed 2016
The new year will mark a significantly shameful milestone for Puerto Rico.
The new calendar year that began 14 days ago marks the ninth year out of 10 that Puerto Rico has experienced stagnation or no economic growth. Sadly, there’s nothing on the horizon that could trigger at least a mild economic turnaround in the foreseeable future.
On the contrary, the island’s lingering fiscal challenges, pending debt obligations, the rise in interest rates by the Federal Reserve, record migration and population loss, and the implementation of a 11.5% value-added tax, or VAT—which includes an increase to the 4% business-to-business (B2B) tax to 10.5%—will continue to stall any prospects of economic growth for the island in 2016 and beyond.
Negative trend continues
A real positive-growth rate of 0.9% in fiscal 2012 interrupted five-consecutive years of negative growth in Puerto Rico’s gross national product (GNP). According to the Puerto Rico Planning Board’s 2014 Economic Statistical Appendix (the most recent edition available), the island’s GNP, in real terms, decreased 1.2% during 2007, 2.9% in 2008, 3.8% (2009), 3.6% (2010) and 1.7% (2011).
“Contrary to the widely held perception, this data indicates that the recession that started in 2006 hasn’t lasted for nine-consecutive years. On the contrary, the 2006 recession ended at some point during 2012, with the economy exhibiting positive, albeit weak, economic growth for a year,” Carlos A. Colón de Armas, economist & finance professor in University of Puerto Rico’s (UPR) School of Business, explained to Caribbean Business.
Following Fiscal 2012’s blip, De Armas said the island returned to negative growth in Fiscal 2013 (-0.2%) and Fiscal 2014 (-0.9%).
“In its economic outlook, the Puerto Rico Planning Board projected the island’s economy would contract 0.9% in Fiscal 2015, which ended June 30, 2015. However, no new data has been published by the agency on Puerto Rico’s GNP,” De Armas added.
As we look toward the future, De Armas said a lot would depend on what finally happens regarding two major threats hanging over the head of Puerto Rico’s economy.
“On the one hand, Puerto Rico continues to lose population. On the other hand, the approach that the government has taken to resolve its fiscal situation will likely have a negative impact on future investment on the island, which augurs negatively for our future prospects,” the UPR professor said. “If the population trend can be reversed, and if the government significantly changes course in its fiscal strategy, Puerto Rico’s economy can be on the mend. Otherwise, we will continue to slide down the abyss, with no end in sight.”
Numbers don’t lie
According to the latest U.S. Census Bureau population estimates released last month, as of July 1, 2015, Puerto Rico had an estimated population of 3.5 million, a decline of 60,706 people, or 1.7%, from a year earlier.
More than 200,000 people are estimated to have left the island between 2010 and 2014, which is a 10% drop. This has created dire consequences for the government’s tax revenues since fewer people are paying taxes.
Meanwhile, the Government Development Bank’s latest Economic Activity Index (GDB-EAI) fell 0.5% year over year in November, driven by drops in cement sales and gasoline consumption, the GDB said last month. The GDB claims its EAI is closely correlated with overall economic performance measured as GNP.
Nonfarm payroll employment increased 0.5% year over year in November, while electric-power generation dipped 0.5%, the GDB said.
According to data compiled by the Studies & Statistics Division of the Puerto Rico Labor Statistics Bureau, employment in the San Juan, Carolina and Caguas municipalities increased by 14,300 jobs in November 2015 versus the same month in 2014.
Last month, the Federal Reserve raised interest rates 25 basis points—the first increase since June 2006—and although it is a modest boost, more rate hikes could be forthcoming in the months ahead.
However, given the very fragile situation of the island’s economy and government finances along with a lack of access to capital markets, an increase in interest rates—even a small one—isn’t a welcome event for Puerto Rico.
For José Joaquín Villamil, chairman & CEO of Estudios Técnicos Inc., making economic projections for 2016, when it is unclear what will happen barely 14 days after the start of the year, is a risky proposition.
“There are, of course, some clear trend lines that suggest that in calendar 2016, the economy of Puerto Rico will once again contract by about 2.4%. What is most important when looking at 2016, however, is identifying the issues that are constraining a return to economic growth any time soon,” Villamil said.
In Villamil’s view, the drivers of this continued contraction include lower public and private spending—which Estudios Técnicos projected will contract by roughly 2.0% and 6.0%, respectively—continued reduction in investment in construction and only modest growth in exports.
“Obviously, the uncertainty generated by the fiscal situation and the impact of the new taxes also influence economic performance. This is particularly true of the 10.5% B2B tax on services and other purchases that goes into effect April 1,” Villamil indicated.
The Estudios Técnicos executive pointed out that what is typically missing in the annual forecasts is the concern for framing these short-term estimates within longer-term trends.
These factors, in the case of Puerto Rico, are major concerns since the economy isn’t expected to grow until 2020, Villamil warned.
“A clearly drafted and inclusive vision of where we want to be five, 10 and 20 years down the road is sorely needed, since it provides the framework for short-, medium- and long-term strategies,” Villamil said. “Intuition and ad hoc measures can be fatal in times like the present.”
This situation, he noted, may seem utopian given the urgency of dealing with the government’s immediate problems, but time flies, Villamil indicated.
“The economy has already been in a negative spiral for 15 years and has been underperforming for 40,” he added.
Fiscal woes dragging economy
Local economist Heidie Calero, president of H. Calero Consulting Group (HCCG), sees Puerto Rico at a crossroads between growth and stagnation. After nine years out of 10 in recession, she insists there are no vigorous signs the worst is over.
“The fiscal situation continues to be a challenge. Unless government perks up, and we need between $11 billion and $12 billion in investments annually, growth won’t be restored,” Calero warned.
To her, Puerto Rico’s crisis is one of credibility and not just a government-liquidity crunch.
“To restore our credibility with investors, financiers and Congress, among others, we need to fulfill our obligation to service the government-obligation [GO] bonds and any other constitutionally guaranteed debt, even if it takes enormous sacrifices in terms of government services and jobs,” Calero insisted.
HCCG forecasts the local economy will contract 3.3% in 2016 and 2.7% in 2017. Unemployment, she projected, will remain high at 13.9% in 2016 and 13.2% in 2017.
“Inflation could be moderate if oil prices remain low and we can effectively address the cost of electricity, with inflation at 1.5% in 2016 and 1.3% in 2017,” Calero indicated. “All in all, Puerto Rico has so many growth opportunities, if we could only focus on a five-year growth plan with participation in public-private partnerships for infrastructure.”
It isn’t enough to go to Congress to beg, Calero stressed, adding Puerto Rico needs to stand proudly and lift itself up again by its bootstraps.
“We did it before…why not now,” she added.
Although 2015 ended without a well-defined framework for renegotiating the public debt, Juan Lara, chief economist at Advantage Business Consulting and economic professor at the UPR, said there is now a clear understanding that the debt-service burden in its present form isn’t sustainable and must be reshaped.
“That’s a major step in the right direction, and we should see more decisive action to reschedule debt in 2016. Taking control of the fiscal picture is essential, lest we end up with a Washington-imposed control board that could complicate matters more than it would help,” Lara indicated.
Even though the García Padilla administration’s growth-
inducing initiatives have paid off in areas such as tourism, aerospace and exports of services, Lara believes much more of that needs to be done.
“More of that is needed to create a sustainable momentum in new economic directions, which is the only real long-term solution for the fiscal, financial and economic challenges we continue to face,” Lara said.
Prepa deal a positive
An agreement reached late last year between the Puerto Rico Electric Power Authority (Prepa) and two of its three monoline insurers is a significant step forward in the electric utility’s restructuring, which could serve as a blueprint for
other government-debt restructurings.
The agreement is also a positive for local banks with Prepa exposure, investment bank Keefe, Bruyette & Woods (KBW) said in its latest North America equity research report.
“The next step in the process should be for the governor [Alejandro García Padilla] to call a special session of the Legislature to pass the Prepa Revitalization Act, which is also required under the restructuring agreement,” KBW’s Brian Klock and Glen Manna said in their latest equity report.
Out of the three Prepa monolines—MBIA’s National Public Finance Guarantee Corp., Syncora Guarantee Inc. and Assured Guaranty Corp.—only Syncora remains out of the deal.
In all, the restructuring accord now includes holders of 70% of Prepa’s roughly $9 billion debt. A group of Prepa bondholders, fuel-line lenders and the GDB had previously agreed to restructuring terms with Prepa.
Local banks with Prepa exposure include OFG Bancorp (OFG, $200 million), First BanCorp (FBP, $75 million) and Popular Inc. (BPOP, $75 million).
The KBW financial analysts pointed out that getting the monoline insurers on board with the restructuring was required by the preliminary restructuring agreement released last month.
“Another major step in putting the restructuring agreement in force is the enactment of the Prepa Revitalization Act by the Puerto Rico Legislature. The governor has yet to call a special session of that body to address the bill,” the KBW equity research report said.
While implementation of the restructuring plan still requires passage of the Prepa Revitalization Act, Klock and Manna indicated they believed an agreement with the creditors brings the Prepa situation one step closer to resolution.
Big debt payments looming
While the local government so far has employed the clawback mechanism—tapping into a revenue stream destined to cover the payment of other debt—to make some debt payments that were due Dec. 1, 2015 and Jan. 1, 2016, it faces several other large debt payments, especially one for more than $1 billion in the summer that could force it to default.
Meanwhile, the government is placing its hopes on congressional action—mainly granting Puerto Rico access to Chapter 9 bankruptcy protection (or the U.S. Supreme Court’s decision in March on the constitutional merits of the local Puerto Rico Public Corporation Debt Compliance & Recovery Act)—to prevent such default.
BY JOSÉ L. CARMONA