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How Strong, How Long?
Industry by industry analysis reveals Puerto Ricos economy will remain strong over the next 12 months.
by JEFFRY VALENTIN-MARI
October 19, 2000
Party poopers: Skyrocketing oil prices, higher interest rates and a cooling U.S. economy threaten to spoil the fun. But the economic outlook remains up beat.
Bulls or bears? Economists will look at numbers. Consumers look in their pockets.
"No matter where you go in Puerto Rico, you see an economy thats booming. Everywhere therere new roads, new housing developments, new cars, new shopping centers, and so forth," Leslie Highley, senior vice president of PaineWeber, told CARIBBEAN BUSINESS.
Puerto Ricos economy has had a remarkable run in the last few years. Businesses around the island are thriving in the best times ever. Unemployment is at its lowest in 30 years. People have got money in their pockets. And they merrily head for the shopping mall.
"From the consumer side of the economy, people in Puerto Rico are spending like never before. You only need to look at the local Treasury Department statistics for the last years to realize how much incomes have grown," said Highley.
During fiscal year 1999, local tax collections hit a record $7.1 billion, up 8.7% or $568 million over the prior year, when revenues totaled $6.5 billion. And 1999 was the second consecutive year that government revenue increased by more than $560 million.
Enhanced tax collections for the general fundthe source of operating funds for the local government to pay for expenses including public workers salaries and wagesare the result of both higher incomes and a broader tax base, i.e., more people paying taxes than ever before.
Officials expect that pattern of growth to be sustained. The Treasury Department reported that the number of individuals filing tax returns for tax year 1999 rose to approximately 875,000, an increase of 254,000 or 41% more than a decade ago (tax year 1990).
The growth of Puerto Ricos economy has been moderate but consistent in the last few years. Puerto Ricos gross productthe total value of the islands output of goods and serviceshas grown by an annual average of 3.3% since 1993.
In fiscal year (FY) 1999, Puerto Rico gross product closed above the initially projected forecast. That year, the economy grew by 4.2%, the highest growth rate in the 1990s. That level of growth was largely the result, however, of an extraordinary injection of fundsapproximately $4 billionfollowing Hurricane Georges rampage in 1998. The trickle-down effect influenced economic activity favorably throughout fiscal 1999.
Still, even without a hurricane in the horizon, the short-term outlook for Puerto Ricos economy remains upbeat.
According to Puerto Rico Planning Board projections, the economy is expected to have grown by a maximum rate of 3.0% in FY 2000 and is projected to grow by a more moderate 2.6% for 2001.
Planning Board numbers for FY 2000 are not yet available.
Despite moderate optimism, experts warn against the possible effects of interest rates, oil prices and a cooling U.S. economy.
"In the coming years, three factors will have a critical effect on the islands expected economic activity: the performance of the U.S. economy, oil prices, and interest rates," Augusto Amato, chief economist of Banco Popular of Puerto Rico, told CARIBBEAN BUSINESS.
"If the Fed [the Federal Reserve Board, which determines U.S. monetary policy] decides to continue with its aggressive monetary policy next year, that would make borrowing more expensive for both consumers and businesses, ultimately slowing economic growth," Amato said.
"In addition, if oil prices remain at their current 10-year high or rise even further, they might trim official economic forecasts," said Amato.
"The performance of the U.S. economy is a key factor in future projections for Puerto Ricos economy," Mohinder Bhatia, president of Puerto Rico Management & Economic Consultants told CARIBBEAN BUSINESS.
"About 40% of the island gross product comes from the manufacturing sector and over 85% of the island exports are headed to the U.S market," said Bhatia. "The implications are profound. If the U.S. economy enters a recession next year that would hurt not only island exports, but would shape a slowdown in the manufacturing activity and therefore in the overall economy."
Economic expert Ivar Pietri, president of development and construction company Peregrine Management warns against exaggerating the potential effects of oil prices and interest rates.
"Historically, interest rates and oil prices have been the major causes of the economic slump or recessions experienced in the early 1970s, 1980s, and 1990s," said Pietri "However, the difference between these periods and todays situation is that neither the Puerto Rico nor the U.S. economy is showing signs of recession."
Pietri may be on to something. So far, no economist of stature is predicting a recession in the U.S. next year. Moreover, some are already projecting a lowering of interest rates in the next few months or early next year. And oil prices last week already took a downward turn from earlier highs.
As a matter of fact, the economic outlook for the U.S. economy has just improved.
According to the latest semi-annual World Economic Outlook, the International Monetary Fund (IMF) flagship report, the IMF raised its forecast for U.S. economic growth in 2001 to 3.2% from 3% it predicted in April. It said the U.S. economy would likely grow 5.2% this year, up from its previous forecast of 4.4% in April. The economy expanded 4.2% in 1999.
In addition, the IMF said the global economy should grow by 4.2% in 2001, an increase from its April estimate of 3.9%. It expects economic activity to expand 4.7% for the whole of this year.
"Puerto Ricos economy is currently going through a structural transformation, whereby the island is becoming a diversified, service-oriented economy," said Amato. The last major transformation took place in the late 1940s when Operation Bootstrap helped transform the island from an agrarian base to an industrial economy based on manufacturing activity.
In order to put the economists outlook of Puerto Ricos economy in a more concrete context, CARIBBEAN BUSINESS asked leaders in five major economic sectors to offer their projections for their industries in the next few months.
Hands down, construction is the most dynamic sector in Puerto Ricos economy today. Since the early 1990s, the construction industry has grown faster than most other sectors, helping to sustain the overall growth of the economy.
Based Puerto Rico Planning Board (PRPB) data, the value of construction investments during FY 1999 edged up to $6.64 billion, a whopping $1.28 billion, or 23.9% more than previous year. That was the second highest growth rate registered year-to-year over the last decade, after the 25.8% registered in 1996.
"Clearly, the construction industry is going through the best times in its history," Jose Vizcarrondo, president of the Puerto Rico Chapter of the Associated General Contractors of America (AGC), told CARIBBEAN BUSINESS.
According to PRPB projections, the value of construction investments in FY 2000 could reach $7.43 billion, $790.9 million, or 11.9% more than the previous year. Of that total, private construction projects will reach $3.67 billion, 4.7% more than in FY 1999. By contrast, the value of public construction could reach $3.76 million, a 19.9% increase over the previous year.
"At AGC, we understand that the local construction industry will remain strong as the ongoing boom continue for another two to three years," said Vizcarrondo.
"Definitely, one factor that has dominated the drive in construction investment in recent years has been private sector projects, particularly in housing," Vizcarrondo indicated.
For the first time in 25 years, in FY 1999 the total value of construction in the private sector surpassed that of the public sector, reaching $3.50 billion or 53%. Total value of public construction reached $3.13 billion or 47%.
Private housing construction investment in FY 2000 is estimated at $1.9 billion, an increase of $405.8 million or 26.8% over 1999. This includes single-family homes as well as apartments.
Vizcarrondo also highlights the expansion of strategic infrastructure projects developed by the public sector. The value of infrastructure projects was $2.32 billion in FY 1999. The largest projects included the Super Aqueduct for the north coast and its interconnection systems, the Urban Train, recycling plant, Route 66, the dredging of Lake Carraizo, new roads (PR-53, PR-10), the Coliseum of Puerto Rico, and Portugues river dam in Ponce, among others.
Perhaps a final factor, but no less important, is that Hurricane Georges-related construction activity continues in 2000, although with much less impact than last year.
But the sweet sometimes comes with the sour. Many industry experts fear that if the construction boom prolongs, the industry might face too strong a demand for raw materialssuch as sand, stone, fine dust, and woodand a shortage of construction workers, particularly highly skilled employees. Both factors have the potential of not only increasing the cost of construction, but also hurting the local economy with a possible hike in inflation.
"Currently, the industry employs 91,000 persons directly, but the PRPB expects the industry will exceeded 100,000 employees next year," said Vizcarrondo. "This is very impressive, because in the last decades the industry has averaged 40,000 jobs annually."
"At AGC, we understand that there are not sufficient construction workers to satisfy the demand," said Vizcarrondo. "In order to alleviate this problem, the association is currently working with both vocational schools and the Labor Department to identify those individuals who might be interested in seeking a job in the construction industry."
Other issues affecting the industry are the concerns over the upcoming November election. Some fear a change in administration could provoke a temporary slowdown in the industry, as some projects may be placed in jeopardy, especially those that have not been contracted yet.
"I think this may not be an adverse effect at all, because both candidates endorse the vast majority of the construction projects," said Vizcarrondo.
The manufacturing industry, like the economy, is currently undergoing a structural transformation. Both the1996 federal legislation phasing-out section 936 and the globalization of the world economy have been deciding factors propelling changes in Puerto Ricos manufacturing sector.
Yet, despite the challenges, industry leaders are hopeful.
For many economists, the current structural transformation is propelled by the 1996 decision of the U.S. Congress to phase-out Section 936.
Section 936 of the U.S. Internal Revenue Code exempted U.S. manufacturing companies in Puerto Rico from paying federal income tax on profits generated from operations on the island. The 10-year phase out program began in 1996. The U.S. Congress replaced section 936 with Section 30A, a more modest tax credit linked to wages paid by those companies in Puerto Rico, rather than on profits. Section 30A allows companies to claim 60% of wages and capital investment as allowance against tax. Puerto Ricos government is lobbying Congress to extend the life of Section 30A beyond 2005.
Another challenge is the pact among the U.S., Canada, and Mexico for the North American Free Trade Agreement (Nafta). This has implications for Puerto Rico because of competition for jobs and investments. Although wage levels are lower in Mexico, Section 30A gives companies in Puerto Rico an advantage in pharmaceuticals and high-tech industries. In low-skill labor-intensive manufacturing such as clothing and footwear, Mexico has the advantage.
"From our perspective, we see a restraint in manufacturing activity for the rest of the year and also for next year," Salvador Vassallo, president of Industrias Vassallo Inc, told CARIBBEAN BUSINESS. "At least two factors are adversely affecting the industry, the rise in fuel and energy prices and the upcoming November election."
"No matter who wins the election, there is going to be a change in government administration," said Vassallo. "And it seems to me that everyone is holding back on expenses in expectation of what is going to happen."
"Despite that, these factors are temporary," Vassallo said. "Were really concerned, because in the last two months our company sales have decreased between a 20% to 30%, to the point that we had to let go 62 workers of a total of 435 employees."
"I believe the manufacturing industry might have to wait until March of next year to see the economy recover its normal path again," Vassallo indicated.
"The current economic situation on the island is very important for us, because we are in the middle of a significant expansion of $15 million," he said. The Ponce company will sell polyvinyl chloride (PVC) pellets thanks to the installation of new technology and the completion of a new 24,000-square-foot building. (CB April 13).
According to Vassallo, the new facilities will be inaugurated in November and they are designed to increase the companys export capacity. "We export not only to the U.S. market but also to the Caribbean, Central America, and South America--specifically to Colombia, Ecuador and Venezuela," he added.
Not surprisingly, official government manufacturing promotion statistics paint a somewhat rosier outlook for the industry on the island.
According to figures provided by the Puerto Rico Industrial Development Co. (Pridco), the number of manufacturing projects promoted rose by 51.2% to 254 in FY 2000, in comparison to 168 in FY 1999. The number of jobs promised to be created with those promotions rose by 142.5% to 29,275 in FY 2000, compared to 12,072 in FY 1999. In addition, the committed investments in machinery and equipment swelled by 253.0% to $117.9 million in FY 2000, in comparison to $33.4 million in FY 1999.
While those numbers are encouraging, many experts believe the long-term vitality of the manufacturing sector on the island will depend on individual companys ability to adapt to changing circumstances worldwide.
"We cant deny that during the last few years, the manufacturing sector has lost jobs, particularly in labor intensive industries, such as apparel, textiles, leather, and food products," Lucy Crespo, president of the Puerto Rico Manufacturers Association (PRMA) told CARIBBEAN BUSINESS.
"However, its also true that labor intensive industries must adopt new technologies in their production lines in order to remain competitive worldwide," said Crespo. "Industries, such as Sara Lee Corp. and Olympic Group Inc. have expanded in recent years by developing high-tech automated processes to reduce labor costs and improve quality, while others like Star Kist Caribe Inc. are preparing to move in that direction."
"The advent of high-tech manufacturing requires a higher level of skilled labor," said Crespo. "In this way, Puerto Rico has the capacity through its human resources to handle changes in technology."
In addition, while some U.S-owned manufacturing companies have downsized or left the island in recent years, other continued to invest in and expand their operations by using alternate organizational and tax structures for new business lines. For example, to date, about 10% of U.S.-owned entities operating on the island have established so-called controlled foreign corporations, or CFCs, allowing a U.S. tax status resembling that of other companies operating in jurisdictions such as Singapore and Ireland.
"Although many manufacturing companies are switching to CFCs for taxable purposes, still others need the U.S. Congress to approve the necessary amendments to extend the life of section 30A," said Lucy Crespo.
"In the coming years we are going to see more manufacturing companies moving aggressively into the research and development (R&D) area because of the advantages offered by the new science & technology policy implemented by the local government," Crespo indicated.
In August 2000, Hewlett Packard Puerto Rico announced that it will receive approximately $46 million over a period of four years from Pridco to invest in R&D on new products and manufacturing processes. The company has committed an additional $54 million to build a new technology center in Puerto Rico. (CB Aug. 10).
"These types of initiatives have been very successful, because many corporations are now interested in participating in this type of joint investment," Crespo added.
In early August, the manufacturing industry received another boost when Pridco and six local entities, including the PRMA, launched a $1 million initiative to promote contract manufacturing investment on the island (CB Aug. 3).
The Puerto Rico Contract Manufacturing Corp. (PRCMC), as the initiative is called, will aggressively market, promote, and execute sales contracts for its corporate members, thereby promoting the establishment of manufacturing, product development, and other specialized industry services for corporations on the island.
"The formation of manufacturing clusters, which are designed to facilitate the establishment of high-tech corporations dedicated to the development of electronic commerce and computer software, will help not only to increase productivity in the economy, but also to raise its level of competitiveness in the new era of digital economy," Crespo explained.
One area the PRMA wants to emphasize is export promotion. "Currently, we are barely at the information stage," said Crespo. "Non-profit organizations, such as the University of Puerto Rico, are currently developing curricula with the assistance of professionals from different fields to provide local manufacturing companies with the know-how for a successful exporting effort.
"At the PRMA, we want to take advantage of the Internet by making strategic alliances with others manufacturing companies in which the Internet would become a mechanism where corporate members would be able to sell their products to other markets," added Crespo.
Although consumers this year dont have the extra money Hurricane Georges winds sent last year, and they are having to spend more for higher fuel and energy prices, and interest rates, commercial activity is expected to remain steady for the rest of the year, according to industry sources.
"Despite the fact that there is less money running in the economy, the number of commercial establishments have increased considerably in recent years," Atilano Cordero Badillo, president of Empresas Cordero Badillo, told CARIBBEAN BUSINESS.
"The economy is not slimming down," said Cordero Badillo. "There is a very important factor influencing the economy that many people dont want to talk about it, which is the informal economy. The size of the underground economy is very significant and in some ways, complements the formal economy, by adding spending power to consumers."
"In general, I dont foresee any further increases in interest rates or large increments in oil prices at least til the beginning of next year," Cordero Badillo said. "I believe that the local economy will end the year fairly stable in terms of growth."
One retail sector that has not performed as vigorously as others is automobile sales. According to the Puerto Rico Automobile Retail Sales Report, local automobile sales edged down by 0.8% to 128,505 units in 1999, in comparison to 129,569 units registered in 1998. For the first five months of this year, the local industry sold 48,728 units, representing a decrease of 5.4%, compared with 51,488 units sold in same period in 1999.
For many in the industry, the sale slowdown was expected and not as related to higher gas prices and interest rates as one might think. Automobile sales are cyclical, characterized by four or five years of steady growth and four or five years of stabilization, thereafter. Since 1994, local auto-dealers have been consistently selling over 100,000 units.
In addition, rising interest rates and higher gasoline prices seem to be having little effect on the auto industry, traditionally a sector sensitive to rates and gas prices. Nowadays, most of the new models are fuel efficient. In addition, battling for market share, automakers have been offering lower rates on auto loans, thereby insulating their customers from the Feds attempt to raise short-term interest rates to slow economic growth to a more sustainable level.
According to industry experts, the decisions by Citibank and Banco Santander Puerto Rico to exit the automobile financing business earlier this year are a response, in part, to aggressive automaker finance companies such as Ford Motor Credit, Toyota Credit, and Chrysler Credit who offer attractive services.
And some in the industry are clearly bullish on the next 12 months. "At Bella International, we believe that the local market is relatively large with great potential for growth and development," Jeronimo Esteves, president of Bella International Corp., told CARIBBEAN BUSINESS. "According to our projections, we expect our sales to increase by 10% for the next year."
Despite its still rather modest contribution of 6.5% to Puerto Ricos gross product, the tourism industry is another key sector of the economy. The industry is profitable and a large employer. Over four million people visit Puerto Rico each year (about one million are cruise ship passengers) and spent about $2.13 billion in FY 1999.
And the prospects are for continued vitality in the upcoming season.
According to the PRPB, 75% of the total number of visitors who visited the island in FY 1999 came from the mainland. This has some important implications for local economy.
"As the U.S. economy continues with its unprecedented expansion, tourists expenditures might increase for the upcoming winter season," said Rick Newman, president of the Puerto Rico Hotel and Tourism Association. According to Newman, the recent increase in the oil prices wont affect the local tourist industry unless it becomes a real crisis like the one experienced in the 1970s.
In addition, the expansion of the islands tourism infrastructure, including the construction of new hotels, is projected to continue on target. The Tourism Co. plans to increase room capacity from the current level of 12,654 rooms to19,100 rooms by 2001. This number would exceed the government long-term objective of boosting the island inventory to 16,000 rooms by 2003, compared to the approximately 8,000 available in 1993 (CB June 15).
The Puerto Rico tourism industry expects to open 11 new hotels in 2001, adding more than 1,900 new rooms to the island inventory. This includes Paradisus Coco Beach Resort & Casino in Rio Grande, Cayo Largo Inter-Continental Beach Resort in Fajardo, Rincon del Mar Beach Resort, Caguas Real Hampton Inn, Embassy Suites Dorado del Mar in Dorado, Casa Suari in Ponce, Dos Mares in Fajardo, Hacienda Punto Pozuelo in Guayama, Hacienda Tropico in Vieques, Ocean Palace in Hatillo, and Punta Maracayo in Hatillo.
This Caribbean Business article appears courtesy of Casiano Communications.