The Year in Review
P.R. Economy Stuck in Winterland
As 2015 comes to a close, Puerto Rico’s economy is entering its 10th year of negative or flat growth, facing well-known challenges of the past, as well some new ones.
This year was characterized by several key events and issues that negatively affected the island’s economy and undermined any chances for growth—both short- and long-term, according to several economists interviewed by Caribbean Business.
Additional credit downgrades into junk territory by the three major credit-rating agencies in late June essentially closed the Puerto Rico government’s dim chances of accessing the capital markets for borrowing. This, in turn, raised the threat of a government default and shutdown, as the commonwealth is quickly running out of cash—and options.
Meanwhile, a massive exodus of Puerto Ricans to the U.S. mainland, estimated at 1,200 people every month, is further shrinking the island’s population and tax base, which further complicates the government’s tax revenue-raising efforts.
The failed attempt at comprehensive tax reform last summer forced the government to approve new taxes, including raising the sales & use tax (IVU by its Spanish acronym) to 11.5% from 7.5%, becoming the highest sales-tax rate in all the U.S.
In addition, the government imposed a new 4% business-to-business (B2B) tax in July, which is slated to go up to 10.5% on April 1, 2016. The government also approved a tax on transfer pricing, targeted specifically at multinational companies doing business in Puerto Rico.
Moreover, several congressional hearings in Washington, D.C. have been held in recent months, in which the Puerto Rico government’s requests for federal assistance to deal with the island’s fiscal and public-debt woes were unsuccessful.
The last congressional hearing, held about two weeks ago in the U.S. Senate, failed to produce a financial control board or Chapter 9 bankruptcy legislation for Puerto Rico.
The latter would have provided the island with a legal mechanism through which to restructure about 40% of the island’s $70 billion public debt.
The commonwealth is now awaiting the U.S. Supreme Court’s decision, possibly in March, on the legality of a local bankruptcy law that could provide a legal recourse to restructure some of its public debt. That law was previously deemed unconstitutional by a local federal district-court judge.
Republicans in the U.S. Senate have proposed legislation to provide $3 billion to help Puerto Rico’s fiscal condition, lowering Social Security payments to Puerto Rican workers and the creation of a federal fiscal control board, but none of these items were included in this year’s federal omnibus spending bill. Neither was legislation that would grant Puerto Rico access to Chapter 9 of the U.S. Bankruptcy Code.
However, Congress did approve 100% parity on Medicare payments for Puerto Rico hospitals, averting a potentially serious crisis in the island’s healthcare system.
Nearly 10 years of negative growth
At the end of the day, the result of these events is that Puerto Rico’s gross national product (GNP), or real growth, is estimated to have contracted by about 2% in calendar year 2015.
In its economic outlook, the Puerto Rico Planning Board projected the island’s economy would contract 0.9% in fiscal year 2015, which ended June 30. However, no new data has been published by the agency on Puerto Rico’s GNP.
To analyze the island’s economic situation during the past year, for our annual Economic Review issue, Caribbean Business talked to four local economists about their opinions and views on the top issues that affected the Puerto Rico economy during 2015.
They are: José Joaquín Villamil, chairman & CEO of Estudios Técnicos Inc.; Juan Lara, chief economist at Advantage Business Consulting and professor of economics at University of Puerto Rico (UPR); Heidi Calero, president of H. Calero Consulting Group; and Carlos A. Colón de Armas, economist and finance professor at the UPR School of Business.
The public debt monster is dragging down the economy
Gov. Alejandro García Padilla’s June 28 declaration to the New York Times that Puerto Rico’s debt was “not payable” spearheaded a long list of credit downgrades by the top-three rating agencies—Moody’s Investors Service, Standard & Poor’s Ratings Services and Fitch Ratings.
The credit downgrades, which pushed Puerto Rico-issued bonds deeper into junk, or noninvestment grade, territory, transpired over a three-day period, June 29-30 and July 2.
The governor’s bleak statement and the quick reaction by the credit-rating agencies brought front and center the island’s precarious fiscal situation and the growing weight of the $70 billion public debt on the government’s finances and the local economy.
The previously mentioned events of 2015—oftentimes uncoordinated and sometimes with contradictory objectives—had the end result of affecting an already hurt economy, Villamil noted.
“There are lessons to be learned from 2015. One is the importance of distinguishing fiscal and economic matters, and the linkages between them. Not understanding these linkages resulted in adopting steps to resolve the fiscal problem that made economic recovery more difficult,” Villamil said. “Could it have been otherwise? Certainly.”
Tax income, he added, had to be increased, but it could have been done with taxes that have minimal impact on economic activity.
“If the economy doesn’t grow at a reasonable rate, there is no way the fiscal issue will be permanently resolved,” the Estudios Técnicos chairman stressed.
No easy solutions to complex problems
In his view, what 2015 made clear is that Puerto Rico’s long-term and deep contraction won’t be easily reversed, even when the downward economic spiral is contained.
“When an economy goes through what ours has gone through, major structural damage is experienced. Returning to a positive growth path will require not just marginal changes such as lowering labor and energy costs or improvements in the permitting process, but also major reconstruction of social, public sector and economic structures,” Villamil commented.
For Advantage’s Lara, 2015 was yet another difficult year for Puerto Rico’s economy, but the year did bring the island closer to a resolution of the burdensome public-debt problem.
In his view, the local economy contracted this year as much as 2% even though the administration’s growth-inducing initiatives have paid off in areas such as tourism, exporting services and aerospace.
“Much more of that is needed to create a sustainable growth momentum in new economic directions, which is the only real long-term solution to the fiscal, financial and economic challenges we continue to face,” Lara stressed.
Although the year will end without a well-defined framework for renegotiating the public debt, Lara 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,” he added.
On the other hand, the year also ended without a strong commitment by the Puerto Rico Legislature to the reform program proposed in the Anne Krueger report and adopted by La Fortaleza, Lara pointed out.
“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,” Advantage’s chief economist noted.
For her part, Calero sees Puerto Rico at a crossroads between growth and stagnation. After more than nine years of recession, she insists there are no vigorous signs that 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 said.
If the Puerto Rico economy were to grow at 1% in real terms, it would take the island 14 years from now to return to the real GNP of 2005, she noted.
On the other hand, if the economy were to grow at 3.4% in real terms, the 2005 real GNP level would be reached in four years, Calero indicated.
“Our crisis is one of credibility and not just a government-liquidity crunch,” the president of Calero Consulting said. “To restore our credibility with investors, financiers and Congress, among others, we need to fulfill our obligation to service the general-obligation bonds and any other constitutionally guaranteed debt, even if takes enormous sacrifices in terms of government services and jobs.”
The year in numbers
Given the lack of timely and accurate government data on the local economy, to assess the health of the local economy and progress toward generating economic growth in 2015, Colón de Armas examined nine economic indicators published by the Planning Board, along with some labor statistics and information on general-fund revenues collected by the P.R. Treasury Department.
Six out of the nine indicators examined performed worse in 2015 when compared with 2014. Five of these indicators—number of construction permits, cement production & sales, electric energy consumption and motor vehicle sales—worsened in 2015 after also having decreased in 2014, Colón de Armas indicated.
“Retail sales decreased in 2014 after having increased the year before. Only three indicators—value of construction permits, hotel registrations and bankruptcies—performed better in 2015 versus 2014, said the economist and finance professor.
On the labor front, the unemployment rate at the beginning of the year stood at 12.4%. That rate represented a 2.5-percentage-point reduction from January 2014, when unemployment was at 14.9%.
“During 2015, the unemployment rate has had its ups and downs, but returned back to 12.4% in October, the most recent month for which data is available,” Colón de Armas said. “ During that same time, the labor-participation rate has increased [slightly] from 40.2% at the beginning of year, to 40.9% in October.”
In addition, between January and October of this year, full-time employment on the island has increased somewhat by 9,000 people, from 995,000 in January to 1,004,000 in October.
During fiscal 2015—ending June 30—Treasury collected about $76 million less in general-fund revenue versus fiscal 2014, and $604 million less than the estimated revenues for the year, Colón de Armas indicated.
From July through November of this year, however, general-fund revenues are running $150 million above last year’s revenue collection, but $24 million below the estimated revenues for the year, he said.
“The above data reflects a mixed bag of economic statistics. For the most part, the economic indicators and the government’s revenue collections reflect negatively on the economy. At the same time, the labor data shows some improvements,” Colón de Armas said.
According to data from the U.S. Labor Department’s Bureau of Labor Statistics (BLS), since January 2012, the island has lost 10,015 net jobs, while the island’s total labor force is down by 37,010 workers.
For Villamil, the island’s employment picture remains cloudy. The unemployment rate, although lower, remains high and of major concern, while manufacturing employment on the island continues to fall, which has been doing so at least for the past 15 quarters.
Easier said than done
Another lesson learned in 2015 is that it is very easy to issue statements on the need to lower government expenditures, as some observers and politicians have done, but very hard to do without affecting services or generating significant social costs, he indicated.
“The government’s committee on restructuring government, headed by then-Secretary of State David Bernier, put forth interesting proposals to improve the efficiency of services, some of which are already in place. The approach adopted by the committee wasn’t to attempt major restructurings, but rather to identify services that could be improved relatively quickly with minimal expenditures and aggressively using technology,” Villamil said.
A Look at the key Issues that Affected Puerto Rico’s top Business Sectors
Despite Puerto Rico’s fiscal and liquidity crisis, there was a lot going on throughout the year that affected the top business sectors. Here are some of those key issues:
In advertising, while always cautious when it comes to talking about numbers, most agencies consulted said 2015 was a good year, with clients investing an average amount in advertising efforts equal to that spent a year ago.
Edgardo Manuel Rivera, vice president of the Puerto Rico Advertising Agencies Association, which groups the most significant players in the local advertising industry, added that the numbers reported may not reflect one of the major areas of investment in advertising: digital.
“We haven’t developed the tools to measure investment [in digital], but it’s clear, it was a strong tendency this year,” he said. “You can see agencies transforming their teams in the area to provide more complete and relevant services.”
Rivera added that another trend has been local agencies coming together and pooling resources to launch media central operations and handle the sale of advertising space or time for clients.
Meanwhile, Luz Irene Mendoza, partner at TBWA San Juan, said another trend in the local advertising agency industry has to do with speed. “It has to do with immediacy in your connection with consumers, being aware of what they are connecting about, talking about and how we can insert ourselves in that conversation,” she said. “To do that the [industry] has had to think and develop strategies that go beyond traditional advertising.”
One thing is certain: Puerto Rico’s creative output proved to be of the highest quality with agencies such as J. Walter Thompson Puerto Rico, DDB Latina and Young & Rubicam Puerto Rico coming away with top awards and finalists spots at festivals such as the Cannes Advertising Festival, the industry’s most important festival celebrated in Cannes, France in June 2015.
The island’s automotive industry is en route to its third-consecutive year of sales decreases. As of November, cumulative sales of new units sold by local dealers amounted to 72,066 units, down 6,601 vehicles, or 8.39% from the same month last year.
The expectation is the local auto industry will finish the year with only 80,000 new units sold in Puerto Rico, despite aggressive promotional efforts, dealer incentives, manufacturer rebates and special tent-sales events to move stalled inventory on dealer lots.
The island’s auto distributors sold 88,200 units in Puerto Rico in 2014, compared with 100,559 in 2013 and 100,790 in 2012.
A 15% reduction in auto excise taxes, in effect since November of last year, hasn’t done much to spur sales of new vehicles on the island, with the commonwealth government reeling from a deep fiscal and liquidity crisis.
The possible reduction in public employees’ working hours, or a full-fledged government shutdown, has forced many local consumers and businesses to put the brakes on their spending plans, especially during the critical holiday season.
“Logically, auto sales are a reflection of the direction taken by the local economy, including decreased consumption and population trends. Our industry seeks to adapt to the times and, therefore, we have been attentive to the retail sector, which so far this year has decreased its market share 10%,” said Ricardo Rivera, president of the United Automobile Importers Group.
Nevertheless, several local distributors and dealers made significant investments this year to improve or add new facilities.
Audi de San Juan inaugurated its revamped showroom facilities in San Juan’s Bechara industrial sector. BMW dealer Autogermana celebrated its 20th anniversary with a $2 million remodel of its facilities on Chardón Avenue in San Juan’s Hato Rey district.
Autocentro invested $5 million in an all-new Nissan dealership on Muñoz Rivera Avenue in San Juan, and remodeling and expanding its Toyota dealership next door. Bella Group invested $5 million in a new Flagship Mazda dealer, to replace the existing one on Kennedy expressway in San Juan.
Banking & Finance
In the banking & finance sectors, the top news of 2015 were the closing of Doral Bank by the Federal Deposit Insurance Corp. (FDIC) and restructuring of operations of UBS Financial Services on the island, respectively.
On Feb. 27, Puerto Rico Financial Institutions Commissioner Rafael Blanco shut down Doral Bank, designating the FDIC as its receiver.
Banco Popular was the lead bidder, entering into a purchase-and-assumption agreement with the FDIC to acquire Doral Bank’s banking operations (including all deposits), purchasing $3.5 billion of Doral Bank’s assets.
Popular then entered into separate back-to-back agreements with three other financial institutions—its U.S. mainland subsidiary Banco Popular North America, San Juan-based FirstBank and Centennial Bank of Conway, Ark.—to acquire 18 of Doral’s 26 bank branches in Puerto Rico, New York and Florida.
Banco Popular assumed deposits and eight of Doral Bank’s branches on the island; Banco Popular North America took the deposits and all three of the failed bank’s operations in New York; and FirstBank snatched the remaining 10 Doral Bank branches in Puerto Rico, including deposits and a performing mortgage-loan portfolio.
In October, UBS Financial Services Inc. of Puerto Rico, the Swiss bank’s San Juan-based subsidiary, eliminated several key divisions in what the company deemed a restructuring of its local operations.
The move—which involved the elimination of the Investment Banking; Credit; Business Development; Marketing; and Government & Institutional divisions and the job termination of eight employees, including top executives and administrative staff—followed the closings and staff relocations from the firm’s Condado (San Juan), Guaynabo and Ponce offices.
The firm’s restructuring continued earlier this month, when UBS Financial Services eliminated staff from its Wealth Management Consulting; Closed-End Funds; Personal & Corporate Trust; and Fiscal Planning divisions, plus some brokers—affecting fewer than 20 employees.
The continuing downsizing responds to the decrease in the firm’s assets and business, as assets under management slid from $15.4 billion in 2010 to $8.7 billion as of June 30, 2015.
UBS Puerto Rico has also been hemorrhaging clients on the heels of more than $3 billion in class-action lawsuits against the island’s largest brokerage firm from investors in the firm’s closed-end mutual funds, which have lost millions as the value of Puerto Rico bonds declined after being downgraded to noninvestment grade.
Puerto Rico tourism in 2015 has mostly been favorable, with its contribution to the island’s gross national product growing to 7.1% this past year, said Gov. Alejandro García Padilla.
The cruiseship sector has fared particularly well. In fiscal 2015, a record 1.5 million cruiseship visitors came to the island, up by 24.8% compared with the previous year. This is mostly due to the $8 million expansion of San Juan’s Pier No. 3, completed in late 2014, with a dredging project for the bay still in the pipeline. This, in turn, allowed several mega-cruiseships to arrive, among them Royal Caribbean’s Anthem of the Seas, the world’s third largest.
New and renovated hotels also made their debut this year, bringing the total number of rooms in Puerto Rico to more than 15,000. Hotel occupancy rates went up to 70.1% in fiscal 2015, as did average room rates.
Among the hotels that completed renovations this year were the San Juan Marriott Resort and Embassy Suites hotels in Carolina’s Isla Verde community and Dorado.
Other hotels were sold off to new owners, among them the Sheraton Old San Juan, which was sold in September; the San Juan Beach Hotel in Condado, sold to Paulson & Co. for $20 million; and El San Juan Resort & Casino, which will undergo a $40 million renovation.
A handful of hotels, among them the Caribe Hilton and Condado Plaza Hilton, also obtained certification in medical tourism.
The casino sector, meanwhile, continued its slide with several closings, among them the Condado Plaza Casino, which closed in July, and the Radisson Ambassador Plaza Hotel & Casino, which closed in April.
This followed moves earlier this year by the central government authorizing the installation of video-lottery terminals (VLTs) throughout the island, in a bid to capture additional tax revenue.
The legalization of VLTs would result in revenue losses for casinos of $68.4 million to $148.8 million a year, according to industry research firm Spectrum. Also this year, the Tourism Co. carried out raids aimed at taking out of circulation some of the thousands of illegal gambling machines.
On the aviation front, several new airlines began serving Puerto Rico, among them Avianca, Volaris, InselAir, Air Europa and Sun Country, while another dozen airlines, among them Norwegian Airlines and Seaborne, added new routes.