Published on May 24, 2010

Sergio M. Marxuach

About two weeks ago, the Center for the New Economy published its third annual assessment of Puerto Rico’s Fiscal Situation. As of May 2010 the Commonwealth’s fiscal situation remains complicated.  With respect to the current fiscal year, projections are for the Commonwealth government to close the books with a general fund deficit of $2.5 billion, which would be the Commonwealth’s eighth general fund deficit in a row.

With respect to next year’s general fund budget, the governor has submitted a budget that is structurally unbalanced in the amount of $1.241 billion, or 15.14% of proposed general fund expenditures.  The government plans to cover this gap with $1.241 billion in non-recurring revenues from the Fiscal Stabilization Fund and from new tax enforcement measures.

In terms of the budget trends, we find that the Commonwealth’s overall fiscal picture remains mixed.  The highlights for this year are:

1. Puerto Rico has undertaken significant efforts to bring the Commonwealth’s finances under control.  These efforts have yielded results in terms of reducing both the budget and structural deficits.
2. The government is increasingly dependent on federal funds for its operations.  During fiscal year 2011 it is forecast that $1 out of every $4 spent by the government will come from Washington.
3. The trend with respect to the general fund budget reveals that government has significantly reduced general fund spending over the last three years.
4. Tax revenues continue to sag.  General fund tax revenues, the principal component of the general fund, have decreased from $7.995 billion in fiscal year 2007 to a projected $7.201 billion during fiscal year 2011, a decrease of $794 million, or 9.93%.
5. Structural balance remains elusive.  The Commonwealth’s structural deficit is projected to be around $1.241 billion for fiscal year 2011.
6. The reliance on non-recurring revenues continues to be worrisome.  Total non-recurring revenues included in the consolidated budget have increased from $506 million in fiscal year 2007 to $2.266 billion for 2011, an increase of $1.760 billion, or 347.8%.
7. Debt service costs keep increasing faster than the economy as well as relative to the overall consolidated budget. The amount of the consolidated budget allocated to debt service has increased from $3.501 billion in 2007 to a projected $4.378 billion in 2011, an increase of $877 million, or 25.05%.  This increase is equivalent to a CAGR of 5.74%.
8. The portion of the consolidated budget allocated to debt service has increased significantly, increasing from 13.23% of the total consolidated budget in 2007 to a projected 16.24% in 2011.  Next year $1 out of every $6 spent by the government of Puerto Rico is allocated for debt service.
9. Finally, Puerto Rico’s public indebtedness continues growing at an unsustainable pace.  During fiscal year 2009 total public debt increased by 9.41%, while Puerto Rico’s GDP increased by only 2.00%.  Furthermore, as of June 2009 the debt to GNP ratio stood at an all-time high of 93.08%, a significant increase from its 58.40% level in 2004.

The control and reduction of government spending has stabilized the Commonwealth’s financial position.  Unfortunately, this stabilization is not cost free.  The implementation of this contractionary fiscal policy in the middle of a four year recession may have deepened and prolonged the economic recession in Puerto Rico.  Furthermore, the government’s pro-cyclical fiscal policy has been implemented at the same time that commercial banks in the island are undergoing a de-leveraging process that has significantly reduced the availability of credit.

Puerto Rico needs new investment to grow but at this point neither the government nor private banks are in a position to finance it.  Issuing additional public debt is one of the few arrows left in the government’s economic policy quiver to stimulate economic growth.  However, with a debt to GNP ratio of 93% as of June 2009, incurring additional public indebtedness appears to be an increasingly unlikely source of financing for new investment over the short and medium term.  In addition, the financial position of most, if not all, public corporations remains weak.  Public Private Partnerships may bring in some new capital, but it is unlikely they will have a significant impact in the short term, and definitely not sufficient to push Puerto Rico out of the recession during fiscal year 2011.

In sum, it will take several years of hard work before the Puerto Rican economy is restored to anything resembling normalcy.  The new normal state of affairs will be significantly different; we will have lower economic growth, higher unemployment, a smaller government, less conspicuous consumption and more saving.  We need to accept this new state of affairs, adjust our behavior accordingly, and get on with our lives.