Este informe no está disponible en español.


A Tale Of Two Islands

While the administration boasts of economic recovery, many businesses in Puerto Rico continue to struggle


July 8, 2004
Copyright © 2004 CARIBBEAN BUSINESS. All Rights Reserved.

Interest rates begin to climb

Higher short-term interest rates reflect an improving business environment of higher growth, low inflation, and employment gains in the U.S. mainland economy. Local businesses, however, remain cautious.

In a much-awaited action, the Federal Open Market Committee of the Federal Reserve (Fed) last week voted to raise the federal-funds rate, a key short-term interest rate, by a quarter of a percentage point to 1.25%, a move perceived by most people as a vote of confidence in the U.S. economy’s recovery.

The Calderon administration had taken the cue early, presenting two weeks ago a rosy picture of the local economy at its fifth State of the Economy Forum with the private sector.

Despite the Calderon administration’s claims of economic recovery in the past 10 months, many businesses in Puerto Rico continued to struggle with slow sales and higher costs in the first half of this year. And although optimistic, many have a guarded outlook for the next six months.

The interest rate hike was the central bank’s first in four years. The federal-funds rate had been at 1%, a 46-year low, since June 25, 2003.

In its announcement of the rate increase last week, the Fed underscored the need for a measured campaign to guide interest rates back to appropriate levels. It suggested its monetary policy responded to positive changes in economic prospects to maintain price stability.

"Simply stated, the Fed has launched a pre-emptive strike to seize and further stabilize the course of the economy," said Mohinder S. Bhatia, president of Puerto Rico Management & Economic Consultants. "The U.S. economy is expected to level its growth at 3% in the next six months while it waits for the manufacturing sector to contribute in full force."

Many in Puerto Rico and abroad believe there will be at least one other increase in the federal-funds rate before year’s end and several more in 2005, given the Fed’s view of a sustained economic recovery. The Fed’s outlook is supported by economic indicators in the U.S., which point to real improvement in retail sales, shipments, durable goods and factory orders, and other areas.

Disinflation, a possible threat only last year in the States, has turned into a low and manageable 2% inflation rate. And the lagging jobs market has seen gains of more than 300,000 jobs per month over the past three months.

Most of the three million U.S. jobs lost in the past four years have been in the manufacturing sector. Recent data, however, indicate the sector is bouncing back. In May, it gained 32,000 jobs.

In June, the U.S. mainland saw its 10th straight month of jobs gains, according to a Bloomberg survey of economists. This overall jobs growth has been perhaps the most critical indicator to the Fed that the nation’s economic expansion could be sustainable at least through year’s end.

No surprise by Fed move

In Puerto Rico, most people in the banking community seem to have taken the Fed’s action in stride. In fact, the general opinion is that the increase had been expected for so long that for the Fed to do otherwise would have been a letdown.

"The recent Fed decision on short-term rates is insignificant for banks," said Richard Barrios, executive vice president & treasurer of Banco Popular de Puerto Rico. "After all, the stateside economy has shown growth of up to 5% for three continuous quarters, which has been apparent to all. During this period, the Fed was methodical about giving signals and preparing the market, including the stock market, for the increase."

"The Fed’s action had no effect on our operations," said Mario S. Levis, senior executive vice president & treasurer of Doral Financial Corp. "This move had already been [factored in] for several months, including the bonds. However, since the Fed said it will continue to increase short-term rates at a measured pace, we will remain vigilant and anticipate events."

Taming inflation

Puerto Rico’s unemployment rate has hovered at around 11% for the past couple of years, and the U.S. labor market has been aggressively trying to recover the millions of jobs lost not only to the economic downturn but also to outsourcing. With prices and jobs stabilizing, it is assumed Fed policy will be geared toward keeping a tight rein on inflation. Consequently, the federal-funds rate can be expected to reach levels that don’t interrupt the economic flow.

"We estimate the federal-funds rate could hit between 1.75% and 2% by year’s end," said Angel Alvarez, chairman & CEO of First BanCorp. "By the end of 2005, this rate could be fluctuating between 3.75% and 4%. The 10-year Treasury note, a benchmark used to fix interest rates on mortgage loans, is projected to move less than 1% to reach 5.25% in 2005. Key factors sustaining these estimates include stable oil prices and employment levels and no catastrophic events."

"We expect the Fed to raise overnight rates another 50 to 75 basis points by year end," said Carlos Garcia of Santander BanCorp.

"Crude oil is extremely important to the island, particularly since it all has to be imported. Luckily, its price is coming down [it is currently some $36 per barrel]," said Alvarez. "Productivity achieved through technology will be another key inflation fighter."

What’s next for the local market?

By all accounts, the quarter-percentage-point increase in the federal-funds rate won’t disrupt commercial lending practices in Puerto Rico. Alvarez said liquidity certainly hasn’t been affected and the new lending rate will still be attractive to developers and other businesspeople.

"The change in short-term rates will affect businesses with lines of credit tied in to the prime rate and commercial customers based on variable rates," said economist Vicente Feliciano, business manager of Advantage Business Consulting. "Credit-card users, for example, could also be paying more on outstanding credit. On the other hand, the economy is money-healthy, with no apparent liquidity issue at this time."

"I expect short-term interest rates to reach 2.5% by the end of this year and 5% by the end of 2005," said Bhatia.

Puerto Rico’s housing market has an opportunity to expand, even though the mortgage-refinancing boom seems to have petered out (suggesting high levels of debt consolidation). Local industry insiders said consumers used their home equity loans in the past few years for 1) home improvements, 2) consumer expenditures, 3) new construction, 4) asset re-evaluation, 5) investments, and 6) financial needs of small-businesspeople.

Statistics indicate the local market still needs 100,000 new housing units, especially social-interest housing. Interest rates on home mortgage loans are based on the 10-year Treasury note, which recently reached 4.63%. "We expect this mortgage benchmark to be closer to between 5% and .25% by the end of 2005," said Banco Popular’s Barrios.

Unlike the federal-funds rate, which is determined by the Federal Open Market Committee, midterm rates (such as the yield on the 10-year Treasury note) respond to supply and demand in the open market. "It wouldn’t be unreasonable to see a 7% prevailing interest rate for those seeking a home mortgage by year’s end," said Ricardo Domenech, executive vice president of BBVA Mortgage. "When you consider rates of as high as 10% only a few years ago, even 7% would still be an acceptable rate."

"Traditionally, our economy has followed that of the U.S., and we can finally see marked improvements in both," said Doral’s Levis. "The Fed has started to gradually carry out its responsibility [and increased interest rates], which leads us to believe that 10-year notes could reach 5.5% to 6% by the end of next year. New-housing construction won’t be affected by tax-exemption issues and financing through GNMA [Ginnie Mae] will allow local banks to pass on a lower rate to customers. Doral Financial expects a 15% increase in mortgage financing, with a 12% increase in new-home financing for the year."

Some are worried, however, that an increase in midterm-note yields could shake things up in the long run. "There is a good possibility that a marked increase in this note [the 10-year Treasury note] could make investments more expensive, dampen spending, and make consumers more hesitant to refinance," said Feliciano.


The increase in the federal-funds rate should have a minimal effect on the local construction industry in the short term, as long as mortgage rates don’t exceed 8%. In fact, mortgage bankers had already started to increase mortgage rates for some time in anticipation of the Fed move.

"Part of the reason sales of new housing have experienced a boom in the past few years has been the prevailing low interest rates," Joel Katz, president of PFZ Properties and chairman of the Governor’s Construction Industry Council, told CARIBBEAN BUSINESS. "As long as interest rates remain reasonable, in the range of no more than 7% to 8%, we will be okay, but the situation could change if interest rates go past 9%."

What this means to consumers, said Katz, is that now is the best time to buy a new home. Katz said he is optimistic about the coming months, even though the elections will effectively turn those six months into four.

"Interest rates have increased, but I don’t think it will be a factor in developers’ decisions to build," said Desarrollos Metropolitanos Vice President Jose Vizcarrondo. "How some projects will be affected by higher interest rates will depend on how much the rates increase in the next six months."

What has really affected the industry in the past few months–and is expected to continue doing so, according to Vizcarrondo–is the steep increases in the costs to purchase and transport materials such as wood; cement; rebar; and electrical, steel, copper, and aluminum components.

"When it comes to single-home residential projects, there could be a 4% price increase; in the case of high-rise commercial and residential buildings, the price increase could jump to 8%," said Vizcarrondo.

Jorge Jose Fuentes, president of the local chapter of the Associated General Contractors of America, said Puerto Rico’s construction industry has suffered successive blows, including delays in the permitting process and higher costs for construction materials and their transportation. Now, it also faces a rise in interest rates.

Fuentes said he expects the next six months to be good for his company and for the industry, as long as the government speeds up the permitting process and the awarding of bids and allows for a price-adjustment clause in government contracts.

Miguel Sabater, president of Bird Construction, said there has been a slight improvement in the permitting process for private-sector projects, but delays are still affecting the permitting and payment processes for some public-sector projects.

"The permitting-process gridlock has been alleviated a bit lately, and developers are finally seeing their projects receiving their much-awaited construction permits. However, there are still gridlock and delays, involving not only private-sector projects but, ironically, public-sector projects as well," said Sabater. "Government agencies are suffering from the same headaches that the private sector has been experiencing for years."

Jose Mendez, president of Punta Arenas Concrete, said he is aware of many private- and public-sector projects that are expected to come out between August and December, which will help his company end the year on a par with 2003. Mendez blames delays in the permitting process for the reduced demand for cement.

"Forget about the higher cost of construction materials. Construction permits aren’t moving along as they should. Complicated projects aren’t moving, much less the smaller, simpler ones," said Mendez.


Puerto Rico’s hotel industry is upbeat about the rest of this year, though its members remain concerned about a number of problems. These include the major limitations on infrastructure; government relations in general; and the chronic, limited supply of trained personnel.

"Our members are experiencing continued momentum this year; they expect continued recovery in 2005 and hope to be back to normal in 2006," said Alain Tiphaine, president of the Puerto Rico Hotel & Tourism Association (PRHTA). "It’s very difficult to get into a promotional mode when you are still recovering."

"More rooms are coming on line this year, and it will be the same next year. It’s going to take time for us to get the numbers back up, and that is assuming we don’t have a major economic downturn caused by another terrorist attack," said Tiphaine.

"Our biggest problem is basic infrastructure strain, and that covers the gamut–electricity, water, telephone service–you name it, we have continuous basic problems with all of them," he said. "They are problems for us and ultimately for our guests. It’s difficult to charge rates when services don’t add up to them."

Another problem for PRHTA members is the limited labor pool. "We have a limited supply of trained personnel," said Tiphaine. "We don’t have people lining up for jobs."

Government relations continue to be a concern for PRHTA members. "A major complaint of our members is the tendency of the Legislature to enact bills as it likes with little or no input from the industry," said Tiphaine. He cited as examples recent bills to increase taxes on loans as well as on slot-machine earnings. "We feel strongly that the government shouldn’t look to the tourism industry when it wants added sources of revenue. When we get these added burdens, it just increases our operating costs, which end up being passed on to our guests, making us less competitive," he said.


The Commerce Development Administration said retail sales in Puerto Rico have increased more than 7% since January, and they should continue improving through 2004 and beyond. Total retail sales are projected to exceed $16.5 billion this year.

"The economy has definitely continued to show signs of picking up," said Epifanio Fabregas, vice president of The Sembler Co. "You can tell just by looking at how traffic and sales have been increasing at shopping malls. We have also noticed that potential tenants are increasingly interested in doing business."

Some in the retail industry believe the elections could slow sales a bit. However, Atilano Cordero Badillo, president of both Supermercados Grande and the Chamber of Food Marketing, Industry & Distribution, said the political campaigns will result in a greater flow of money.

"An estimated $30 million will be spent on election campaigns this year. That money will fuel an increase in various business sectors, including media, transportation, and publishing, benefiting the economy as a whole," he said.

Cordero Badillo added that he believes proposed antibusiness legislation won’t have a negative impact on the local economy because it won’t be passed. In fact, as of press time, the House and the Senate had rejected bills that would have granted vacation and sick-leave benefits to part-time employees. The consensus in the retail industry was that these and other proposed bills would increase the cost of doing business in Puerto Rico, which would scare away investors and ultimately hurt local consumers.

Gov. Calderon supports administration’s economic development decisions from past three-and-a-half years


In view of the recently announced economic expansion Puerto Rico has sustained during the past 10 months, Gov. Sila Calderon said her administration was correct to emphasize job creation and company retention through incentives in the past three-and-a-half years.

Gov. Calderon reviewed some of her administration’s accomplishments in a private interview with CARIBBEAN BUSINESS held at La Fortaleza after the fifth and final state of the economy forum last month. During the conversation, the governor revealed what her three most important economic development initiatives had been. She also described why public works investment came late in her administration and emphasized the need to balance the interests of the executive and legislative branches.

Of her administration’s three most important economic development initiatives, Gov. Calderon said she was proudest of the effective management of the government’s finances, the creation of 17 new tax-incentive laws, and the close to $8 billion in public-works investment.

"First and foremost, turning around the government’s finances [allowed us] to implement other initiatives," said Gov. Calderon. "The fact that we were able to do away with the deficit; pay the Puerto Rico Government Development Bank’s hidden debt by issuing a record $25 billion in new and refinanced debt; and recover $1 billion from the federal Education, Housing, and Family departments was a coup. We did this in the middle of the recession with discipline, professionalism, patience, and perseverance along with a great team who worked very hard. And this was the source of everything else, including the money we collected for public-works investment."

New tax credits and exemptions to establish new companies and technology on the island and encourage manufacturing and exports were part of the governor’s first initiatives during her administration. Seventeen laws offering incentives for buying companies going out of business, local products for export, and equipment and machinery were approved. Other laws incentivized the creation of new businesses on the offshore municipal islands of Vieques and Culebra. Additional incentives aimed to help U.S. mainland or foreign companies establish their call centers and Caribbean headquarters’ divisions in Puerto Rico.

Final results of these laws have been mixed. Five companies bringing innovative science and technology to the island were granted 0% to 2% tax rates (Abbott Laboratories, Amgen, Johnson & Johnson Cordis, Eli Lilly & Co., and Medtronic). Twenty-six companies applied for 50% tax credit equivalents when they bought closing local operations. However, for stateside companies that are exempt from taxes to begin with, the export law is hardly useful. As such, it needs to be amended to make it more attractive for these firms.

Easing up on public works investment

After a slow start, the Calderon administration’s investment in public works began to be felt this year. Accordingly, the number and value of construction permits increased 9.9% and 1.7%, respectively, from January to April 2004.

According to the governor, the reason public-works investment was held back was because her administration was unprepared for the fiscal situation left by the Rossello administration.

"If I knew then what I know now!" said Gov. Calderon. "We really had to understand what was happening and approach the rating agencies very carefully for them to believe us. At one of the presentations, I accompanied [Infrastructure Financing Authority President] Juan Agosto Alicea and my now-husband, former Economic Development & Commerce Secretary Ramon Cantero Frau to a meeting [with a rating agency], something that is unheard of for a governor. I said that I was head of the financial council and saw myself as a [former Chrysler Corp. Chairman] Lee Iacocca, but hopefully better looking and nicer!"

During the economic forum, the governor said that by the end of her term, 4,027 public works projects will have been completed at a cost of $7.9 billion.

Striking a balance between the executive and legislative branches

The economic forum took place during a troubled time for the executive and legislative branches. Prior to the end of the legislative session on June 25, hundreds of bills were being discharged with no explicative reports. Meanwhile, the governor was being pressured by various business sectors to support or reject crucial measures such as new antitrust, environmental, and construction laws; sick leave/vacation benefits for part-time employees; and new taxes on offshore banks’ loans.

When speaking of her relationship with the legislative branch, the governor said they were able to work together to create a stable financial environment.

"It worries me that there was a perception that some of the proposed legislation was being endorsed by the executive branch," said Gov. Calderon to CARIBBEAN BUSINESS. "The most important thing for [Puerto Rico’s] investment climate…is confidence, trust, and security. Money and investment go where it is secure. That is its nature, the essence of business."

The governor explained that the executive branch holds the balance of power, with the ministerial obligation of approving bills and making them a reality–or not.

"In that balance of power is the essence of democracy," said the governor. "It doesn’t mean that every piece of legislation under consideration will become law, nor does it mean that the executive branch will veto every single piece. What the executive branch–the governor in this case–has to do is balance the different interests because I don’t represent just one interest. I don’t represent just the workers, the business community, the environmental groups, or the civic groups. I represent everybody."

By the end of the legislative session, the antitrust, environmental, and construction law bills were put aside for more analysis, as were legislations regarding sick leave/vacation benefits to part-time employees and tax on offshore banks’ loans.

"My obligation is to balance all the interest groups, thinking of what is best for Puerto Rico in general," said Gov. Calderon. "Right now we are coming out of the recession. We had this economic upturn in December 2003 and the reason we have kept it going until now is that we have stimulated and incentivized the business sector, the sector that provides and generates jobs. My foremost interests are the workers and jobs, so I am so delighted that we have had results. We are in expansion and I have to be sure as governor that the expansion continues to flourish."

Why the apparent communications breakdown with legislators who were elected after supporting her political platform? The governor calls it the result of democracy.

"Differences [with the legislative branch] stem from the different backgrounds of the people who are in the process. And the process is that way because that’s how democracy works. Teachers, workers, legislators, and all kinds of officers who come from different backgrounds are represented and have different ideas and agendas. So that’s why it’s so important that the ones selected fit with the times, because different times demand different things," said the governor.

Electricity costs and attracting new companies remain a problem

Energy costs continued to haunt companies’ operational budgets during the Calderon administration. In 2001, the Puerto Rico Electric Power Authority (Prepa) announced it would invest $3.5 million in a hedging, or insurance, program to protect the island from fluctuations in the price of oil. So far, $10.3 million in savings due to price fluctuations have been deposited in Prepa’s Customer Fund.

"The cost of electricity will go down when we use less petroleum," said the governor. "There is a plan and the person who has it is [Prepa Executive Director] Hector Rosario. I feel embarrassed to say [that the hedging program] was my idea. Somebody gave it to me when I was at a reception [in New York]. It’s a good idea, but we have to use other sources. [By having a long-term plan for electricity generation…the cost will be reduced] and it will be a good promotional tool for Puerto Rico. But again, we come to the cost of doing business in Puerto Rico. We live on an island and sometimes believe we exist by ourselves, for ourselves, and that nobody else is around. But everyone is competing–Mexico, the Dominican Republic, Singapore, Haiti, and Ireland–for our jobs. So if we want to keep them, we have to keep our costs down."

As to the failure of replacing Internal Revenue Section (IRS) 956, the governor blamed political foes working against the measure in the U.S. Congress. According to Gov. Calderon, the amendment to replace IRS 956 was something her administration came up with at the last minute as an incentive for Puerto Rico. "All this effort we put into IRS 956 was opposed for political reasons…I hope [another incentive] is approved because it is important in the long-term [for Puerto Rico]. But we also came up with other laws that help balance and compensate for the loss of IRS 956. Nonetheless, we have to keep striving for federal incentives," said the governor.

In the meantime, business organizations complain about the lack of new companies establishing operations in Puerto Rico. According to Gov. Calderon, there have been new investments in new biotechnology plants, for example, and promotional efforts and campaigns have been successful. Nonetheless, few new pharmaceutical or biotechnology plants as such have been established. Rather, pharmaceutical companies have expanded, adding biotechnology operations, or technology-driven companies have added new product lines or more advanced sciences. Although there has been increased promotion by the Puerto Rico Industrial Development Co. (Pridco), the agency has suffered from a lack of cohesiveness and guidance due to the departure of three executive directors in three years.

According to the governor, she ends her administration wishing she could have spent more time on the Special Communities initiative, a program whose aim is to help low-income neighborhoods on the island. It is funded with $1 billion from redirected fund assignments from eight government agencies including Prepa, the Puerto Rico Aqueduct & Sewer Authority, the Municipal Affairs Commissioner’s Office, and the Infrastructure Financing Authority.

"Frankly, I would have liked to have more time for the Special Communities," said the governor. "I’ve done two things I think are very important. I’ve turned finances around and reduced corruption in government processes and I feel proud of that. But we also brought the heart back to the government by directing huge efforts towards the [Special Communities’] people, our brothers and sisters who had been left behind."

It hasn’t been an easy administration for Gov. Calderon, and she admits it. Given her business background, she is proud of the skills that got her through what she feels were difficult times.

"I was here [as governor] at this point in time and I’m glad because the times were so difficult," said Gov. Calderon. "I’m glad that a person with a business background was at the helm. I enjoyed it very much. It has been a privilege and an honor for me and I would do it all over again. But this was no easy task."

What is the federal-funds rate?

Federal funds are reserve balances at Fed banks that depository institutions (banks) can lend to one another. The federal-funds rate is the interest rate that banks charge one another for lending these funds overnight. The Federal Open Market Committee sets a target level for the federal-funds rate and attempts to reach that target by buying or selling Treasury securities on the open market.

CARIBBEAN BUSINESS Associate Editors Jose Carmona and Taina Rosa and Contributing Editor John Collins contributed to this story.

This Caribbean Business article appears courtesy of Casiano Communications.
For further information, please contact:



Self-Determination Legislation | Puerto Rico Herald Home
Newsstand | Puerto Rico | U.S. Government | Archives
Search | Mailing List | Contact Us | Feedback