Puerto Rico’s economy
Economic growth for the island has been flagging in recent years and unemployment is rising. The unemployment rate was estimated at 13.8% in May, 2014, by the Bureau of Labor Statistics—over twice the national average. Currently owing about $70 billion in debt, economic growth is crucial for the island’s government to be able to continue servicing its debt obligations.
The market for municipal debt (MUB) is estimated at about $3.7 trillion, compared to $12.1 trillion for Treasury (TLT) securities (Source: SIFMA). A default by the government of Puerto Rico would have significant impact on exchange-traded funds (or ETFs) that have investments in Puerto Rico’s debt.
Some ETFs like the PowerShares Insured National Municipal Bond Portfolio (PZA), have exposure to insured debt issued by the government of Puerto Rico. Puerto Rico Commonwealth Public Impt 5% is the top holding in PZA at 5.43% of assets. Unlike most debt issued by the island of Puerto Rico, the issue is insured which should protect investors.
For more information on the Puerto Rico’s debt downgrade, please read the Market Realist series A Puerto Rican default: Its effect on the municipal bond market.
New York Fed’s recommendations for Puerto Rico
In 2011, led by Dr. William Dudley, the New York Fed had commissioned a report on the major economic issues facing the island of Puerto Rico. The report’s mandate was to “analyze the challenges facing the Puerto Rico economy and to put forth recommendations on how to capitalize on the island’s strengths and restore growth.” The report, which released in 2012 made the following recommendations to “improve the island’s competitiveness over time.”
- Reduce barriers to labor force participation and job creation,
- Reform the energy industry, particularly, improve the efficiency of the electric utility’s operations,
- Lower the costs of doing business,
- Foster partnerships between industry and higher education, and
- Promote independent policy evaluation.
In his speech on June 24, Dr. Dudley also spoke of improvements that had taken place since the report was released. Specifically, he discussed the bill reforming the energy sector and the use of alternative sources of energy as a means of reducing the island’s high energy costs. Dr. Dudley also spoke about the island’s thrust on business development, notably in pharmaceutical (PJP) and knowledge-based industries.
Major ETFs with investments in the pharmaceutical space include the PowerShares Dynamic Pharmaceuticals Portfolio (PJP). Top ten holdings in PJP include companies like Pfizer and Amgen, both of which are part of the S&P 100 Index (OEF).
Fresh fiscal challenges faced by Puerto Rico
However, Dr. Dudley also pointed out that the economic and fiscal situation has been faced with fresh challenges since the report was issued in 2012. The large operating deficits in public corporations had raised public debt levels in the Commonwealth leading to “serious concerns about whether the Island’s fiscal position” was “sustainable.” For this reason, an update to the 2012 report is planned which would take these issues into account. We’ll discuss more of these fiscal and economic problems that Dr. Dudley pointed out in the next section in this series.