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Economic Year in Review 2004

Disappointing economic growth…again; 2004 ended better than 2003, but not good enough


December 30, 2004
Copyright © 2004 CARIBBEAN BUSINESS. All Rights Reserved.

Puerto Rico’s economy underperforms again in 2004

A year of sluggish economic growth and plenty of politics

Any way you look at it, the global economy had an outstanding year, the best since 1984. During 2004, world economic growth was about 4.5% and was mainly driven by the U.S. mainland, which grew 4% and China with 9% growth. The economies of Latin America and the Caribbean region also reached an estimated 5.5% growth.

"Latin America and the Caribbean experienced an exceptionally good 2004," said Inter-American Development Bank (IDB) President Enrique V. Iglesias last week during his annual year-end address to the IDB’s board of executive directors. Most Latin American countries did well thanks to China’s appetite for the region’s raw materials and commodities and remittances from workers in the mainland U.S.

Compared to the above level of growth, Puerto Rico had another disappointing year. Again, the island’s economy failed to achieve adequate growth and continued to fall behind the rest of the U.S. and other competitive economies. Puerto Rico’s economic recovery during the year was moderate at best, although it was an improvement over the previous three years.

Island’s growth rate

Real growth during the government’s fiscal year 2004 (July 1, 2003 to June 30, 2004) was 2.7%. Growth during the calendar year 2004 is expected to range between 2.2% and 2.5%. This reduction during the second half of the year was partially due to oil price hikes that surpassed $55 per barrel of crude, sending premium gasoline prices over $2 a gallon. The high prices of gasoline placed additional pressure on consumers’ disposable income and discretionary spending. According to analysts, every $10 per barrel increase costs the local economy an estimated $750 million, money that isn’t available for spending on other goods and services.

Most economists agree that in order for Puerto Rico to achieve adequate growth levels, proactive and aggressive measures must be implemented or the economy will continue to experience sluggish growth.

"We haven’t done well for the last 25 years," pointed out Estudios Tecnicos’ President Jose Joaquin Villamil in a recent interview. Heidi Calero, President of H. Calero Consulting Group, also confirmed that at the end of the year Puerto Rico finds itself lagging compared to other developed economies.

During 2004, Puerto Rico also failed to take advantage of the productivity gains in the mainland U.S. Government officials also failed to rethink and redirect the island’s obsolete economic model. Productivity continued its sluggish growth. According to economist Villamil, "Productivity growth in Puerto Rico has averaged only about 1% per year for the past 12 to 14 years."

Economy remained dependent on public sector

In 2004, the participation rate in the labor force remained under 50% and the average unemployment for the year was over 10%. Although services continued to dominate the job market, most new jobs were in the public sector or entry-level positions, with the government employing 30% of the salaried employees. In November 2004, the government’s payroll climbed to 327,000 employees.

The government also failed to adequately simplify, streamline, and expedite the permitting process to facilitate investment. Government intervention and bureaucratic processes continued to be an obstacle to improving productivity. David H. Chafey Jr., president of Banco Popular, pointed out that too much regulatory burden makes companies invest a lot of money and time, putting greater pressure on businesses. "What is needed is to simplify the way business is done. Unfortunately, Puerto Rico’s Legislature is evaluated by how many projects are passed, and that isn’t good because what counts is quality and not quantity," said Chafey.

The economy continued to be driven by public investment and government expenditures, as is always the case during election years. Yet, despite this, the quality of life in Puerto Rico didn’t improve. The public education system continued in shambles; streets remained unsafe; and Puerto Ricans continued moving in large numbers to the U.S. mainland, especially to Florida. It is estimated that in 2004, 650,000 Puerto Ricans resided in Florida, up from 480,000 in 2000.

Four years into the 21st century, Puerto Rico remains at an economic crossroads, with the need to revamp its economic, social, and infrastructure model. The island continues, steadily and surely, to fall behind economically. To make matters worse, there is no confidence a highly politicized commonwealth government can adequately address Puerto Rico’s economic and social problems.

Leonardo Cordero, president of the Puerto Rico Chamber of Commerce, pointed out that during the past few months, various conditions have contributed to uncertainties in our society and economy. Among them, the drawn-out results of the November elections, the Puerto Rico Aqueduct & Sewer Authority (Prasa) strike, government deficits, the battles over tax reform, and the much anticipated, federal General Accounting Office (GAO) report on the island and its possible consequences regarding congressional actions in Puerto Rico. These factors contribute to instabilities in the island’s investment climate and reduce economic growth.

Manuel Maldonado, senior vice president at Quality for Business Success (QBS), says Puerto Rico must become more competitive by improving its economic performance, the efficiency of the government and private sector, the physical and human infrastructure, and the island’s social cohesion. Nevertheless, Maldonado points to the resiliency of Puerto Rico’s economy that even under difficult conditions is still able to achieve moderate growth.

Politics dominated 2004

Politics dominated the scenarios in Puerto Rico and the mainland U.S. during most of the year. President George W. Bush was overwhelmingly re-elected and Republicans strengthened their control in Congress. Hispanics also made major inroads in the U.S. political arena with the election of two Hispanics to the U.S. Senate. Puerto Rican voters on the mainland–as U.S. citizens and eligible voters–were crucial in the Florida election in both the presidential and Senate races.

Unprecedented in Puerto Rico’s political history, a first-term incumbent governor didn’t seek re-election, and cabinet and agency heads’ resignations reached epidemic proportions. The second half of the year was dominated by an often vicious political campaign that failed to address Puerto Rico’s real political, economic, and social issues. After counting, recounting, lawsuits, and countersuits in federal and commonwealth courts, Puerto Rico’s Electoral Commission certified Popular Democratic Party (PDP) gubernatorial candidate Anibal Acevedo Vila as Puerto Rico’s eighth elected governor.

Luis Fortuño of the New Progressive Party (NPP) was elected resident commissioner to the U.S. House of Representatives, making 2004 the first time a governor and resident commissioner from different political parties have taken office. Fortuño is also the first Republican that Puerto Rico has sent to the U.S. Congress.

The NPP dominated easily in both houses of the Puerto Rico Legislature, as well as 43 of the island’s 78 municipalities. The PPD retained control of the municipalities of Caguas, Carolina, Mayaguez, and Ponce, while the NPP kept Bayamon, Guaynabo, and San Juan.

In 2004, members of the Presidential Task Force on Puerto Rico’s Political Status visited the island to meet with local political leaders, but departed without making any comments. The release of the federal General Accounting Office (GAO) and bipartisan Joint Committee on Taxation report on Puerto Rico’s economy, which was mandated by Congress and due in 2004 was postponed for release in the spring of 2005.

Taxes still unresolved

During the year, the U.S. Congress didn’t address the issue of economic tax incentives for industries in Puerto Rico although these will end in 2005. Congressional inaction came as no surprise in most economic sectors, but what wasn’t expected was that Puerto Rico would be left out of the congressional legislation to reduce taxes on manufacturing companies.

The Federal Reserve also began increasing interest rates from their 45-year low and rates are expected to continue a moderate trend upward during the next year. A devaluated dollar made U.S. and Puerto Rico’s imports more expensive and exports more competitive. However, since the largest share of Puerto Rico’s trade is with the mainland U.S., the impact on a local level was minimal.

In the local government arena, no comprehensive tax reform was implemented, although it became an issue during the gubernatorial campaign. The Treasury Department (Hacienda) also failed to make public the recommendations obtained from the multimillion-dollar Bearing report on the island’s taxes that was commissioned by Hacienda.

The debate regarding Puerto Rico’s adoption of a sales tax or value-added tax to eliminate the costly excise tax escalated, becoming a controversial issue during the election campaign. Most politicians, however, missed the real issue, which is that Puerto Rico needs not only a tax reform, but also a complete overhaul of its fiscal system, according to economist Villamil. Putting additional patches on the island’s tax system won’t alleviate the existing burden on taxpayers and local businesses.

Economist and tax expert Ramon Cao warned that to maintain Puerto Rico’s bond ratings, complete tax reform must be implemented. "For the last 50 years, Puerto Rico has implemented amendments to the tax system that have contributed to increasing its complexity, to the erosion of the tax base, increased costs, and have degraded the fairness of the system," Cao stated.

In addition, Cao says tax reform won’t be sufficient unless it is accompanied by a close analysis of the fiscal side–meaning government spending–and the management of public corporations.

In FY 2004, Treasury Department general fund net revenues amounted to $8.4 billion, an increase of $320 million or 4.5% compared to FY 2003. About 72% of the government’s consolidated budget pays for operational expenses, another 13% goes to pay the government’s debt and only 15% is invested in capital improvements.

As of June 30, 2004, Puerto Rico’s constitutional debt stood at $7.5 billion and the debt to be paid by legislative appropriations at $7 billion, bringing the commonwealth’s debt to $14.5 billion. In addition, public corporations owed $17.4 billion and municipalities over $2 billion, bringing Puerto Rico’s total public debt to almost $34 billion.

During FY 2004, Puerto Rico issued $7.6 billion in bonds consisting of $3.4 billion for refinancing of debt and $4.2 billion in new debt. This new debt is in addition to $11.6 billion issued by the Calderon administration since January 2001. When Calderon took office, the public debt stood at $23.8 billion. In November, the Government Development Bank (GDB) reported to the commonwealth government’s transition committee that $17.2 billion had been issued in new debt since January 2001, bringing the public debt to over $40 billion, an increase of over 70%.

Although Puerto Rico’s public debt is classified by Standard and Poor’s as A- and by Moody’s as Baa1, in September, Moody’s changed its outlook on the government’s general obligation (GO) bonds from stable to negative. This was mainly due to Moody’s concerns regarding the Calderon administration’s need to obtain loans from the Government Development Bank (GDB) to balance the 2004-2005 budget and the government’s pension fund, which lacks capital. A request to authorize approximately $2 billion in Pension Obligations Bonds (POBs) to cover the actuarial pension liability and ease concerns of credit-rating companies wasn’t sent to the Puerto Rico Legislature in November as anticipated.

From FY 2003 to FY 2004, the share of the GDB’s total assets devoted for agencies and public corporations’ loans increased from 31% to 47.6%. At the end of FY 2004, the GDB reported assets of $9.2 billion, an increase of approximately $340 million from the previous year. Net assets increased to $2.31 billion, up from $2.16 billion in FY 2003. Net income of $153 million was about the same as the previous fiscal year.

As of October, Puerto Rico had an available margin of 5.8% meaning that the island’s central government could still issue approximately $3.4 billion in additional debt.

Projects that did or didn’t happen

In February 2004, Gov. Calderon announced the Urban Train was 99% finished; that structural errors had been corrected; complaints were resolved, and the project would be inaugurated soon. But it took almost a year for the train to finally take off and, in the middle of December, it began providing free weekend trips to the public.

The Government Financial Center site in Santurce remains pretty much what it was in 2003, not much more than a site. The renovation and expansion of La Concha and the Vanderbilt hotels in Condado are well underway and the hotels are expected to open in 2005. Puerto Rico’s Coliseum in Hato Rey, renamed Jose Miguel Agrelot, finally was inaugurated and began holding major events, after recommendations three years ago that what had been built be imploded. The finished coliseum is now in continuous use and admired by local and visiting entertainers and promoters.

The Port of the Americas in Ponce was renamed Jose "Churumba" Cordero, but not much else happened. The position of the port’s executive director remained vacant. Nothing was disclosed regarding the CB Richard Ellis development and marketing contract for the value-added zone to support the port facilities in Ponce. In addition, recommendations of CB Richard Ellis’ second contract for the proposed redevelopment of Naval Station Roosevelt Roads in Ceiba encountered opposition from area residents.

In April, Prasa officially returned to the hands of the commonwealth following almost a decade of private administration that ended with the cancellation of Ondeo’s contract. On Oct. 4, only six months after the government had taken over, Prasa’s Independent Authentic Union hit the picket line, in a strike lasting almost three months. In the meantime, Puerto Rico was losing up to 50% of its water resources as a result of poor management and an obsolete infrastructure.

In May, the Puerto Rico Legislature introduced a series of antibusiness legislation that would have government bureaucrats running the island’s businesses and employees. In several front-page stories, CARIBBEAN BUSINESS sounded the alarm alerting the business community to these legislations. The following week, in an unprecedented move, Puerto Rico’s private sector united and rallied against the measures and forced the Legislature to discard the proposed antibusiness measures.

In September, Tropical Storm Jeanne hit the island and the Puerto Rico Electric Power Authority (Prepa) system collapsed, in some areas for over a week, costing millions of dollars to businesses and the economy. By December, the Federal Emergency Management Agency had approved $385 million in federal assistance.

Also in September, the light-rail train proposed from Caguas to San Juan ran into a bureaucratic roadblock at the Highway Authority, when the engineer in charge of the project resigned. Other infrastructure projects suffered the same fate during the year. Highway 66, renamed Corredor del Este, which should have been finished years ago, is still under construction, as are the proposed Maunabo tunnels. Two major highway construction bids went deserted. The development plan for Vieques and Culebra, which is still undergoing changes, remained as so many others, nothing more than a government plan. The amount of solid waste continued to increase, an urgent problem for the island, while the proposed Waste-to-Energy Plant for Caguas continued to be just that, a proposal.

Consulting firm A.T. Kearny got paid more than $3 million for Project 2025 by the Department of Economic Development & Commerce and the Puerto Rico Industrial Development Corp. to deliver a presentation on Puerto Rico’s problems and future economic challenges. Project 2025 was touted as the model for creating the economic development strategies and solutions for Puerto Rico over the next 20 years. The project didn’t go beyond a PowerPoint presentation with just over 500 pages. The proposal to make San Juan the headquarters for the Free Trade of the Americas Agreement (FTAA) also lost steam without government support from the Calderon administration.

In December, it was learned that the Special Communities initiative, which was supposed to be implemented with a $1 billion "perpetual" fund to help low-income neighborhoods throughout the island, was funded with $1 billion from redirected fund assignments from government agencies and a GDB loan. Most of the funds already have been committed.

Industries’ performance manufacturing

Expansions and the production of medical devices helped sustain the manufacturing industry. According to the past president of the Puerto Rico Manufacturers Association, Manuel Cidre, the industry held its own without many surprises. "We finally have adjusted to the new economic reality," he stated.

Manufacturing sustained itself with expansions of companies already in Puerto Rico, which also generated jobs in construction and related industries. However, very few new companies started manufacturing operations. At the end of FY 2004, the Planning Board reports there was a 3% increase, to 120,000, in manufacturing jobs. But it wasn’t until the end of the Calderon administration that expansions in the industry became a reality. Major expansions in the medical devices sector were indicative of a health sector that is acquiring importance as an alternative to pharmaceutical treatments. One of the largest was announced in early December when Johnson & Johnson announced the $25.4 billion acquisition of Guidant, a leading manufacturer of cardiac rhythm management devices.

There were 53 plant closings throughout Puerto Rico during FY 2004, an increase of 20% compared to the previous fiscal year, with 1,683 jobs lost; while 183 companies were opened, generating 7,987 new jobs, according to the Puerto Rico Industrial Development Co.


The local construction industry, a pillar of Puerto Rico’s economy, remained strong thanks to prevailing low interest rates, strong demand for new housing, and the revival of public sector infrastructure projects.

Public and private construction permits registered moderate but important increases during the six months of the year. During FY 2004, construction permits for public projects increased by 27.4% and private construction by 5.5%. The value of the permits also increased by 7.4% in the private sector and 10.3% in the public.

Private-sector representatives, however, expressed concerns over the rising costs of steel and petroleum-based products and their effect on ongoing construction projects, as well as delays of government-issued construction permits. Some of the island’s leading developers started looking toward Florida for opportunities to develop projects.

The much-awaited revival of public-sector projects, which in fiscal years 2001, 2002, and 2003 showed a marked decline from previous years, arrived too late according to industry experts. Tired of waiting for public construction projects to take off, major contractors turned to private-sector developments in order to avoid losses or having to lay off their employees. When the bids for the public-sector projects emerged, late in FY 2003 and early FY 2004, contractors already had maxed out their bonding and personnel capacity and were unable to absorb any additional projects. As a result, bids for many public-sector projects went ignored by contractors, as was the case with the Maunabo tunnel project.

Planning Board numbers for the first four months of FY 2005 (July 2004 to October 2004), however, paint a less rosy picture. The total value and number of government-issued permits dropped 4.8% and 5.9%, respectively, compared to the same period in FY 2004. In real terms, the total value of construction permits issued decreased $50.1 million, from $1.054 billion during the four-month period to $1.004 billion or 4.8%. Meanwhile, the total number of permits went down from 3,503 permits issued during FY 2004 to 3,298 in FY 2005, a difference of 205 permits or 5.9%.

The private sector experienced a 12.1% decrease in the value of permits during the first four months of FY 2005, while the value of construction permits in the public sector increased 15.7% during the same period. Despite efforts by the Calderon administration to jumpstart the local construction industry, the number of private- and public-sector permits declined by 2.3% and 40.2%, respectively, during the first four months of FY 2005 compared to same period in FY 2004.


Recent figures from the Construction & Sales Activity report show 20% of all home sales are under the $110,000 benchmark, while another 20% are over $300,000. The median price for homes in Puerto Rico was $188,700. There was considerable investment in low income or social interest housing. The private sector developed over 27,000 units with an average price of $80,000. Public investments in housing reached $240.7 million, 55.5% over the previous fiscal year.

Housing demand continued to be impacted by demographic changes–aging population and fewer households being formed– and moderate increase in interest rates. Demand for social-interest housing is projected to continue at a rate of 10,000 units per year. Housing reports indicate the local market still needs 100,000 new housing units, especially social-interest housing. New housing permits jumped to over 20,000 during FY 2004 with a value of over $1.2 billion.


Puerto Rico’s imports in FY 2004 reflected a $5.1 billion increase over FY 2003, from $33.7 billion to $38.9 billion with manufacturing reflecting a $5 billion increase. Exports registered a $95.1 million decrease over the same period, with chemicals decreasing $2 billion, and manufacturing in general showing an $88.4 million decrease. According to official Planning Board figures, FY 2004 was the best year for imports in a decade; however, it was also the worst year for Puerto Rico’s exports.


Local and stateside commercial investors set their sights on Puerto Rico this year, pouring in billions of dollars to take over well-known shopping centers, fast-food chains, and even shoe store chains. Meanwhile, new retail players began opening stores in Puerto Rico and expanding existing stores.

The local retail industry–comprised mainly of megastores, supermarkets, franchises, pharmacies, and department stores–posted a total of $17.2 billion in sales during fiscal year FY 2004. This represents an increase of 6.4% over the same period in 2003, when sales totaled $16.1 billion, according to reports from the Puerto Rico Commerce Development Administration.

Low interest rates, special financing deals, manufacturer’s rebates, dealer incentives, and new vehicle offerings helped the auto industry increase their sales by nearly 6%. About 130,000 new vehicles are slated to be sold by year’s end, up 5.8% or 7,206 more units than the 122,794 sold in 2003.


Several new hotels, some expansions, and three executive directors of the Puerto Rico Tourism Co. sums up 2004 in Puerto Rico’s tourism industry. According to Tourism Co. statistics, the island continues to depend on the U.S. market for tourists, with more than 68% visiting from the U.S. mainland. The threat of terrorism overseas and the declining value of the U.S. dollar have helped Puerto Rico’s tourism industry by keeping travelers closer to home and under the U.S. flag.

In FY 2004, the average occupancy rates at hotels and paradors (small inns) increased by 14.1% to 79.1% compared to 64.9% in FY 2003. Hotel occupancy held steady during the peak season (Dec. 15 to April 15) reaching 95% in some cases.

Financial sector

Puerto Rico’s financial industry was without a doubt the shining star of Puerto Rico’s economy with growth in the securities, commercial, and mortgage sectors.

In spite of limited growth in other areas of the local economy, the financial industry demonstrated its strength and fortitude. The banking sector continued to grow exponentially. Increased competition and improved competitiveness in all areas forced financial institutions to work harder and the results were evident.

According to the Office of the Commissioner of Financial Institutions, as of Sept. 30, total assets in Puerto Rico’s financial system were over $180 billion compared with $157.5 billion as of Dec. 31, 2003. During the same period, the commercial banking sector alone increased its total assets by approximately 19%.

The overall favorable performance of the financial institutions led many of them to look toward the U.S. mainland for further growth opportunities to diversify their asset base and grow, with Florida playing a key role.

Chafey explained that although the banking sector helps to fuel the rest of the economy, it can’t work alone. "The financial sector will continue to contribute and fuel the economy, but there need to be other factors that contribute to further growth," he said.

One of the factors that helped the economy is the development of new construction projects, which continues growing and feeding the mortgage sector. Many financial institutions sought to incorporate mortgage services into their products, given its growth in spite of interest-rate concerns.

The mortgage-industry sector increased total assets by close to $578 million in just three quarters. Victor Galan, chairman & CEO of R&G Financial Corp., pointed out that it was the strength of its mortgage operation that allowed the financial-services company to expand into new areas and develop other products.

The Puerto Rico Stock Index, mostly made up of financial-sector stocks, closed the year in near-record territory. Mainland U.S. investors also took more notice of local bank stocks this year. One analyst pointed out without hesitation that local bank stocks outperformed U.S. bank stocks in many cases.

As of Sept. 30, total assets among the investment companies were $10.8 billion, an increase of over $2 billion from the end of calendar year 2003.


Locally owned companies, which dominate the island’s insurance industry, are now positioning themselves to enter and take over other markets by merging or acquiring other companies, both in Puerto Rico and on the mainland U.S.

During the past decade, Puerto Rico’s insurance industry–which generates some 30,000 direct and indirect jobs–has experienced steady growth. Currently, the industry’s subscribed premiums surpass $4 billion, according to the Insurance Commissioner’s Office. Of that total, locally owned companies were in charge of subscribing 80%, with foreign or stateside companies the remaining 20%.

Before hurricane season, the insurance market was looking pretty soft compared to previous years, when reinsurance prices increased due to the great losses sustained on 9/11. With all the storms and hurricanes that hit the Caribbean and the southern region of the U.S. during the season, including four hurricanes in Florida and Tropical Storm Jeanne in Puerto Rico, a hike in reinsurance likely will lead to hikes in insurance policy rates in 2005. Jeanne is estimated to have generated over $1.5 billion in damages in Puerto Rico alone.


The fight for equality in Medicare dominated the health industry as the increase in reimbursements for Puerto Rico, from 50% to 75%, approved by Congress in October, continued to fall short compared to the 100% reimbursement hospitals receive on the mainland U.S. Alfredo Volckers, president-elect of the Puerto Rico Hospital Association (PRHA) and executive vice president of Pavia Health, pointed out that if the 100% formula were applied to Puerto Rico, where Medicare recipients pay the same premium as do stateside recipients, PRHA member institutions "would receive approximately $316 per every Medicare patient. Given the current 137,000 patients discharged every year, it would translate into an additional $43 million a year," said Volckers, who was also CARIBBEAN BUSINESS 2004 Person of Year in the private sector.


The Department of Agriculture announced gross agricultural income for FY 2004 was $781 million compared to $760 million in FY 2003. The largest growth sectors were ornamental plants, with an increase of $17 million, for a total of $51.1 million; coffee, registered an increase of nearly $10 million, for a total of $45 million; bananas, which increased close to $5.1 million, for a total of $17.5 million, and tomatoes, grew by nearly $5 million, for a total of $13.3 million.

Not enough

While many sectors of Puerto Rico’s economy did better in 2004 than 2003, it wasn’t simply enough nor was it anywhere near the growth reported in the mainland U.S. and other developed economies. As the island welcomes 2005, with a new government administration, the economy is one of the major challenges that must be addressed by incoming officials. With the increasing cost of petroleum and Puerto Rico’s high level of dependence on government jobs, and global competition becoming more aggressive, the new administration will be hard-pressed to examine the commonwealth’s economic model early in the term. Otherwise, 2005 will be another disappointing year for Puerto Rico’s economy.

This Caribbean Business article appears courtesy of Casiano Communications.
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