EIU says PR economy on ‘road to recovery,’ but obstacles are many - caribbeanbusiness.pr
EIU says PR economy on ‘road to recovery,’ but obstacles are many
By CB Online Staff
Analysts at the Economic Intelligence Unit (EIU) are voicing cautious optimism that Puerto Rico is finally pulling out of its economic doldrums, but warn that big obstacles remain to a substantial rebound.
“After many years of recession, Puerto Rico’s economy appears to have hit bottom and is now on a slow road to recovery,” the EIU reported in its latest island bulletin.
The advisory and analysis firm expects Puerto Rico’s gross national product will grow by 0.5% in fiscal 2012 (which ends June 30), which is short of the island government’s forecast of 0.7% growth.
The EIU expects growth to gain steam to 1.4% in fiscal 2013, as credit conditions improve and trends in several domestic sectors continue in a positive direction. The Fortuño administration’s efforts to support the rebound with a medium-term development strategy, which most recently included the enactment of a law that provides tax incentives to promote Puerto Rico as a hub for export services, could help to lift this to higher rates over the medium term, the report said.
The EIU notes that Puerto Rico has not registered growth since fiscal year 2006, when it expanded by just 0.5%. This was followed by five years of contraction. By comparison, during this stretch of time the mainland U.S. economy shrank in only one year, 2009 (by 3.5%), during the depth of the global financial crisis.
The island’s poor performance is the result of a combination of factors, including eroding competitiveness, structural changes in the manufacturing industry (particularly pharmaceuticals, a major component of Puerto Rico’s manufacturing base), the phasing out of federal tax incentives for producers on the island and the local government’s severe fiscal imbalances, the report said.
“The latter has required a major fiscal retrenchment effort by the administration of Gov. Luis Fortuño in order to keep the government running and maintain Puerto Rico’s credit rating and access to financing. This has had a negative impact not only on public spending but also employment, as the public sector is a major provider of jobs on the island,” the EIU said.
Signs of recovery
“Against a backdrop of fiscal adjustment, the economy has remained weak,” the report said. “However, select indicators have begun to show a clear improvement.”
The Puerto Rico Manufacturing-Purchasing Managers Index has been above a threshold that reflects expansion for 14 of the last 20 months. Exports in fiscal year 2011 totaled $64.9 billion, 5.2% over the prior year. Retail sales grew by 2.8% year on year in 2011, and by 4% in December alone. Auto sales in 2011 also showed modest improvement, with growth of 1.5% year on year. In the important tourism industry, the occupancy rate reached 69.2%, up 1.5 percentage points over 2010.
The report notes the positive impact from more than $7 billion in federal stimulus funding for Puerto Rico through the American Recovery & Reinvestment Act. Some $5.9 billion (83.5%) has been disbursed, largely for infrastructure projects. The Fortuño administration’s $500 million local stimulus plan has also pumped $365 million into the island economy.
“However, as these funds will soon be depleted, the government’s recovery strategy is based on a medium- and long-term plan to boost Puerto Rico’s competitiveness, attract investment to new or growing sectors, focus more on innovation and research and development, and promote the island as a business hub connecting the North America with the broader Caribbean and Latin American area,” the EIU said.
New tax breaks created
One step in this direction is a new law to aggressively foment growth of the local services industry and the exportation of services, thereby diversifying the drivers of economic growth and attracting new private capital.
The Export Services Act (No 20 of 2012) aims to turn Puerto Rico into an international center for legal, consulting, financial, engineering and other forms of services. The law provides for 20-year decrees, renewable for 10 additional years, which guarantee the tax breaks cannot be subject to subsequent legislative changes.
Under the decree, a new outside business setting up in Puerto Rico to provide services for export (or an existing local service provider that expands into exports) will be subject to a 4% flat corporate income tax rate (compared with the normal local rate of 30%), with a possibility of lowering this to 3% if exports are the main revenue generator of the company. Distributions from earnings and profits from such ventures will be 100% tax exempt in Puerto Rico. The operation will also be exempt from property taxes.
As a complement to this act, lawmakers passed the Individual Investors Act (Act 22 of 2012), designed to attract investors and high net worth individuals to take up residence in Puerto Rico. Benefits include 100% exemption from local taxes on interest and dividends, and on long-term capital gains accrued after the person becomes a legal resident. It is hoped that the act will attract business professionals (or retirees) to relocate to the island and will further encourage foreign or mainland-based services companies to set up shop there.
The EIU is not optimistic on Puerto Rico’s chances of landing a new federal industrial lure in the short term.
Puerto Rico has continued to lobby legislators in Washington to amend Section 933 of the U.S. tax code by adding a clause that would allow U.S. companies in Puerto Rico to benefit from US tax provisions permitting dividends paid to a parent company on the mainland to be tax-deductible. The measure, which has not advanced, would partially replace special benefits provided to Puerto Rico under Section 936 of the tax code, which expired in 2006.
“The issue might not be considered until the US Congress takes up a more comprehensive overhaul of the tax code, which is much discussed in political circles but does not look to be on the horizon,”
Too soon to tell
“It is too soon to determine whether Puerto Rico’s latest efforts to boost economic growth and diversification will bear the desired fruit,” the EIU said.
In the short term at least, the government’s ongoing fiscal squeeze will keep government consumption and investment low, according to the report. The economy also suffers from very high rates of unemployment, and this will continue to dampen private demand. A strong dependence on imports, particularly of fuel, will also hinder growth.
Externally, conditions also remain fragile.
Although the EIU no longer foresees a risk of recession in the U.S., and forecasts U.S. GDP growth of 1.9% in 2012, this is far below the rate of 3% enjoyed in 2010.
“Sluggish U.S. growth will limit expansion of Puerto Rico’s tourism, services and retail sectors,” the EIU said. “Recession in the euro zone, and the risk of an oil price spike, will also dampen Puerto Rico’s growth prospects.”
.svg){kind=small}
.svg){kind=small}
