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A Puerto Rican default: Its effect on the municipal bond market

Part 3
A Puerto Rican default: Its effect on the municipal bond market (Part 3 of 9)

Will the Governor manage an economic overhaul for Puerto Rico?

The previous Puerto Rican governors have tried to relieve the fiscally distressed economy by raising taxes, laying off 33,000 government workers, etc., but all in vain. What can Governor Alejandro Garcia Padilla, who took over the office last year, do differently to save an economy that is heading toward a default? The economy has already borrowed heavily to the point where it has tapped out.

Puerto Rico Economic IndicatorsEnlarge GraphIn a statement, Governor Padilla said, “This is a government that awards incentives to those who have the guts to provide jobs to people at a time of pessimism, that stems the emigration of our loved ones and halts the contraction in various economic sectors.” Padilla does recognize the key issues that need to be addressed first in order to save the economy from defaulting on its public debt.

Incentives to motivate employees

The current unemployment rate of 15.4% is one major area that needs to be addressed. The governor is already more than halfway toward reaching his often-repeated campaign pledge to create 50,000 new jobs during his first 18 months in office.He has vowed not to lay-off any workers. He is also aggressively promoting incentives to entice wealthy investors like hedge fund billionaire John Paulson, who has invested in an exclusive beach resort and condo complex.

Immigration is a major concern

With the exodus of professionals and middle-class Puerto Ricans moving to Florida and Texas in search of better jobs, there is a need to retain intellectual capital within the economy.

Also, there certain other measures that the government is taking to reduce the fiscal deficit.

Increasing taxes

An additional $1.3 billion in taxes has been sought, through increased corporate taxes, a broadened sales tax, and a new gross receipts levy. The corporate tax has been increased to the maximum of 39%. Although, because of the way the tax is structured, it hits companies with a less than 5% net profit margin the hardest, like food-related companies and supermarkets (smaller margins lead to higher taxes). This may cause certain businesses to flee from the island. Despite the situation, businesses like Eli Lilly (LLY), Seaborne Airlines, and Cooper Vision, a business unit of Cooper Companies, Inc. (COO) have arrived in Puerto Rico.

As Puerto Rico has been an attractive manufacturing destination for pharmaceutical companies, it needs to attract top U.S. multinationals like Johnson & Johnson (JNJ), or Pfizer (PFE) to solve many of its problems. The iShares U.S. Pharmaceuticals ETF (IHE), and the Invesco PowerShares Dynamic Pharmaceuticals Portfolio (PJP) track the performance of the pharmaceuticals sector of the U.S. equity market. Both these ETFs include JNJ and PFE in their portfolios.

Rebalancing pensions

The governor has overhauled three major pensions, including trimming the pension for teachers. He has also shifted many government workers from traditional pensions to 401(k) type retirement plans, while raising retirement ages and increasing employee contributions to the plans.

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