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Puerto Rico Is On A Roll!

Economy to outdo remarkable 1990s performance and edge ahead of national economy by mid-decade

by Francisco Javier Cimadevilla

January 13, 2000
Copyright © 2000 CARIBBEAN BUSINESS. All Rights Reserved.

Double, double, toil and trouble;
Fire burn and caldron bubble...


After a remarkable performance during the better part of the last decade, Puerto Rico's economy appears poised for sustained growth in the first decade of the 21st century.

Moreover, the first available forecast for the next few years has the island's economy outperforming the national U.S. economy by mid-decade.

For many, both learned and uninitiated, economic forecasting may be less scientific than witches conjuring up the future around a cauldron. Yet, scores of local business and corporation managers will make decisions involving millions of dollars in budget projections and allocations based on those forecasts.

In the last 10 years, Puerto Rico's real gross product (i.e., the total value of goods and services in constant 1992 dollars) grew at a moderate average annual rate of 2.8%. But the economy's rate of growth improved significantly as the decade progressed. The last seven years, for example, averaged real growth of 3.1%. And the Planning Board's preliminary estimates for economic growth in fiscal year 1999 are 4.2%.

Economists disagree as to what these numbers mean. Many even dispute the validity of official government economic statistics altogether. But there are areas of consensus.

First, even government economists concede that last year's 4.2% growth was unusually high due to the massive influx of capital in the wake of hurricane Georges recovery efforts. "At least 1.3% of the growth experienced in fiscal year 1999 was attributable to the hurricane. Our original forecast had the economy growing between 2.7% and 3.1%. By adding the effect of the hurricane, you come close to the 4.2% preliminarily estimated by the [Planning] Board," economist Heidi Calero told CARIBBEAN BUSINESS.

Second, most economists agree that even though moderate economic growth hovering around 3.0% is better than the marginal growth 0.8% and 0.9% that marked the beginning of the decade, it is simply not enough. Given the still developmental stage of Puerto Rico's economy, most economists think that it should exhibit growth rates higher than those registered by the national economy, a phenomenon economists term "convergence".

"During the 1960's and 1970's Puerto Rico's economy tended to converge with the U.S. During the 1980's and 1990's we have been diverging," Estudios Tecnicos president Jose Joaquin Villamil told CARIBBEAN BUSINESS.

Yet, convergence is precisely what economists at Estudios Tecnicos forecast will happen again by the year 2003.

From 2000 through 2002, Estudios Tecnicos forecasts moderate real growth rates averaging 2.3%, which is lower than the 2.7% growth predicted for the national U.S. economy. By 2003, however, the forecast has Puerto Rico edging ahead with real growth of 3.1% in 2003 and 3.4% in 2004 compared to the national economy's 2.7% and 2.5%, respectively.

In the case of both U.S. national and Puerto Rico economies, Estudios Tecnicos forecasts more moderate growth in the next three years than what they have exhibited in recent years. "In the year 2000, U.S. economy growth is seen dropping below 3.0%, in large measure owing to interest rate increases engineered by the Federal Reserve," states the Estudios Tecnicos report.

"In Puerto Rico, indicators suggest key components of domestic demand are slowing down, although growth of government revenue indicates there's still a dynamic streak in the eight-year old expansion. In the year 2000, there will be some push from public sector demand, as there usually is in election years. On the private side, rising interest rates and a slowing U.S. economy will tend to slow internal demand, although not significantly," states the report.

But by the year 2003, Estudios Tecnicos' economic forecast has the local economy picking up steam, with construction, retail, and tourism leading the expansion.

Stars in the pack

Investment in construction will remain relatively strong in the medium term, although it's expected to taper off into a more moderate and sustainable expansion, again, picking up steam by 2003 and 2004 with growth rates of 6.1% and 6.5%, respectively.

According to the forecast, two factors account for the expected health of the construction industry: interest rates are expected to rise only moderately and major infrastructure work already underway or projected should keep public investment in construction growing strongly. "While growth in private construction will level off somewhat, some government-sponsored mega projects will continue to fuel growth in construction," says Villamil.

Other economists concur. "Construction will continue to be the "star" performer in our economy for the foreseeable future. My preference would be that the lead sector be a productive sector, such as manufacturing," commented Calero.

Calero explains that manufacturing sector performance has been a mixed bag. While manufacturing employment on the island has shrunk during the last 10 years, manufacturing payroll has increased, as have the values of manufacturing output and export sales. "Exports continued growth is a good sign, although it's inconsistent with the reduction in manufacturing employment," says Calero. Increases in productivity and transfer pricing probably account for the apparent inconsistency, she said.

According to Estudios Tecnicos' forecast, retail sales--which registered $13.7 billion in 1999--should soar to $18.4 by 2004. And consistently with other indicators in the forecast, retail sales are expected to reach higher growth rates of 7.2% and 7.3% in 2003 and 2004, respectively. "There's no doubt that Puerto Rico's financial sector continues to have great confidence in local consumer ability to repay. To that extent, personal consumption will continue to perform strongly," noted Calero.

Perhaps the most significant growth in the Estudios Tecnicos forecast goes to the tourism sector. By 2004, annual tourist arrivals are forecast at 5 million, compared to 3.6 million in 1999, and annual tourist expenditures are expected to reach $3.4 billion in 2004 compared to $2.3 billion in 1999. Again, the most significant aspect of the forecast is that growth rates for both tourist arrivals and expenditures are expected to spike up sharply by mid-decade, reaching 11.9% (tourist arrivals) and 12.9% (expenditures) in 2004, considerably higher growth rates than these categories have experienced during the 1990's.

Villamil says the reason behind the more dynamic performance of Puerto Rico's economy by mid-decade lies in some of what has been done in the last few years. "What we've done is to lay a foundation. There are a number of initiatives that have been launched but aren't expected to yield short-term results."

Science and technology, a recently launched initiative, exemplifies areas where results aren't expected before four or five years. "Of course, that presumes for the next two years we do what the strategic plan calls for: make requisite investments in the technology corridor, establish centers of excellence, and give out the science and technology grants," warns Villamil.

Calero agrees. "Puerto Rico must stop exporting the past and start exporting the future," she says. "We must get in the business of manufacturing and exporting products based on newer technologies, whether in computers or telecommunications. The problem is that we still don't have adequate incentives to attract those operations to the island. You need much more than a policy on Science and Technology. We have to recognize that tax exemption continues to be an exceedingly powerful tool to attract investment. Not just corporate tax exemption. It's time we consider preferential tax treatment for individuals [whom we want to attract to Puerto Rico to perform research and development of new technologies]."

Likewise, in the area of tourism, it appears Puerto Rico has barely begun to scratch the surface. Despite significant growth in room inventory and massive investments in marketing the destination during the last decade, some of the most significant growth--tied to such mega projects as the new Convention Center, cruise ship piers along the Golden Triangle, and other hotels in the pipeline--won't kick in until mid-decade.

Clouds in the sky?

Both Villamil and Calero concede that the favorable economic outlook for Puerto Rico depends on continued positive performance of the U.S. national economy. Stability in the price of crude oil and low interest rates are key factors.

"Most industry observers take for granted that the Fed will authorize an interest rate hike next month and perhaps again in March," said Calero. "Though I hope it's not more than 50 basis points, it could be as much as 1%." Calero notes Puerto Rico's government and other borrowers correctly took advantage of lower interest rates in the past few years to refinance outstanding debt. "That was a good move. Still, regardless of who's in charge, Puerto Rico's new administration will go to the bond market in less favorable circumstances, which should be taken into account."

Calero worries less about possible interest rate hikes than about negative fallout the Vieques issue may have on the economy. "It's a huge black cloud. Washington's political establishment may take reprisals against Puerto Rico by cutting federal funding." Calero notes federal funds are an excruciatingly important factor in Puerto Rico's economy. "They don't necessarily fuel growth, but they're tremendously important for stabilizing the economy."

What about the second part of the decade? "We feel optimistic," says Villamil. "From 2005 to 2010 we expect to see real term economic growth around 4%, perhaps even surpassing that figure."

Villamil warns, however, that growth will require continued effort.

"That forecast requires the same prescriptions we've advocated in the past: lower transaction costs (i.e., overall cost of doing business in Puerto Rico); improve infrastructure, both physical (emphasizing telecommunications and transportation) and social (health and education); foster science and technology industries; deregulate and privatize; and make private sector more proactive in articulating an economic vision for the future.

This Caribbean Business article appears courtesy of Casiano Communications.
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