Puerto Rico and its Economy
Puerto Rico (also referred to as the “Island” or the “Commonwealth”), a Commonwealth of the United States of America, is the easternmost of the Greater Antilles and the fourth largest island of the Caribbean. The Island is located at the crossroads between North and South America, at just 3.5 hours airtime from New York and 60 minutes from Venezuela and has a population of approximately four million people. As in the rest of the United States, the Island has a local judicial system. The Island constitutes a district in the federal judiciary and has its own U.S. district court. Also, most of the U.S. federal agencies are represented on the Island. However, the Island has its own internal revenue system and is not subject to U.S. taxes. Spanish and English are the official languages of the Island.
The Island uses U.S. currency and forms part of the U.S. financial system. As a Commonwealth of the U.S., the Island falls within the U.S. for purposes of customs and migration, and therefore there is a full exchange of funds, people and goods between the Island and the U.S. Puerto Rico banks are subject to the same Federal laws, regulations and supervision as those of the financial institutions operating in the rest of U.S. The FDIC insures the deposits of Puerto Rico chartered commercial banks, including Westernbank, the banking subsidiary of W Holding Company, Inc.
Factors affecting the U.S. economy usually have a significant impact on the performance of the Island economy. These include exports, direct investment, the amount of federal transfer payments, the level of interest rates, the level of oil prices, the rate of inflation, and tourist expenditures, among others. During the Commonwealth’s fiscal year ended June 30, 2008, approximately 75% of Puerto Rico’s exports went to the U.S, which was also the source of approximately 50% of Puerto Rico’s imports. In the past, the economy of the Island has generally followed economic trends in the overall U.S. economy. The U.S. economy, which was severely hit by the housing-market and credit crises, entered into a recession in late 2007.
The economy of the Island is mainly driven by the manufacturing and service sectors. The manufacturing sector has experienced positive and negative changes over the past years as a result of increased emphasis on higher wage, high technology industries such as pharmaceuticals, biotechnology, electronics, computers, microprocessors, professional and scientific instruments, and certain high technology machinery and equipment, in addition to the reduction of tax incentives. In recent years, the service sector also has played a major role in the economy, leading all sectors in providing employment.
During 2008, the Island continued to be in a prolonged economic slowdown, which has led to a recessionary cycle. The main drivers contributing to the recessionary cycle include budget shortfalls, economic weakness within the manufacturing and construction sectors, diminished consumer buying power driven by increases in utility costs, gasoline prices, highway toll charges, the implementation of sales taxes and periodic impasses between the Executive and the Legislative branches of the Island government. Historical declines have occurred in the local manufacturing sector. Three important indicators for the manufacturing sector (jobs, hours worked and payroll) pointed toward the continued weakening of local manufacturing activity. During 2008, the manufacturing sector lost approximately 7,700 jobs in comparison with figures reported in 2007, for a decrease of 7.20%, although many multinational corporations continue to have substantial operations in the Island. As in 2007, the construction sector, a historical backbone of the Island economy, continued to be relatively weak during 2008, as the combination of the current Commonwealth’s fiscal situation and a decrease in the public investment in construction projects has dramatically affected the sector. The value of construction permits during the year ended December 31, 2008 declined when compared to 2007, with most of the drop coming from the public sector. The multiplier effect of a decrease in capital investment has been already felt in other areas of the Island economy, with the banking sector one of the most affected.
The banking sector has been historically the financial support for all the industrial and commercial activity on the Island. At December 31, 2008, there were ten FDIC insured banks operating in Puerto Rico, with total assets, loans and leases-net and deposits of approximately $99.5 billion, $61.2 billion and $64.0 billion, respectively. U.S. banks, foreign banks and the major Puerto Rican banks all offer commercial banking services designed to support the emerging requirements of their local clients as well as of their international clients. Historically, the economic strength and liquidity of local financial institutions, considered the pillar of the Island’s economy, have allowed the Puerto Rico banking sector to extend credit, without which the Island’s economy could not be sustained. The growing combination of loans, deposits and assets historically has been the key to the economic progress for the past years.
Throughout 2007 and 2008, the banking sector has experienced a reduction in the credit quality of, and a worsening of trends affecting, its residential mortgage, commercial and construction loan portfolios, particularly new housing development projects which have been affected by the continuing deterioration of the economy, in addition to the oversupply of new homes at all levels. And while the Puerto Rico housing market has not seen the dramatic decline in housing prices that is generally affecting the U.S. mainland housing market, there is lower demand due to diminished consumer acquisition power and confidence, among other things. Since 2008 the Island government has taken actions and implemented tax incentives initiatives designed to boost the demand of the housing market. However, there can be no assurance that these actions will help to boost the Island housing market.
Other economic indicators for 2008 showed additional signs of weakness. With the exception of the total civilian population, all the indicators of job-market performance reflect a downturn. The total labor force, number of jobs, participation rate, and number and percentage of unemployed all continue to show signs of deterioration. The Island unemployment rate, which has been historically higher than the average U.S. unemployment rate, increased to 13.5% at December 31, 2008, the highest since 1999. According to the Puerto Rico Labor Department, a total of 1.2 million people were employed in Puerto Rico at December 31, 2008, which represents a decrease of approximately 24,000 jobs, or 2.0% when compared to December 31, 2007. The rate of participation in the labor force fell from 46.1% in 2007 to 45.0% in 2008.
Activity in the tourism sector has also shown signs of weakness, as hotel registrations, hotel occupancy rates and passengers movement each decreased when compared to 2007 as a result of the continuing deterioration of the U.S. and Island economy.
Future growth of the Island economy will depend on several factors including, the economic condition of both the Commonwealth and U.S, the level of interest rates and changes to existing incentive legislation, among others. At the end of fiscal year 2008, the Island remains in a recession. The recent crisis in the capital markets and consequent restrictions on credit could add to the uncertainty prevalent on the Island as a result of the prolonged stagnation of local economic activity, or impact the economy’s ability to grow, which would impose additional limitations on recovery in the foreseeable future.