Why is Puerto Rico’s economy unique compared to mainland U.S.?

A notable difference from other mainland jurisdictions is that Puerto Rico’s balanced budget requirement, while found in the constitution and relatively stringent in form, appears not to have been effective in constraining the growth of the Commonwealth’s debt,” said New York Fed chief, Dr. William Dudley in a speech to the Certified Public Accountants of Puerto Rico, in San Juan, on June 24.

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Among the other notable differences, Dr. Dudley mentioned that the residents of Puerto Rico, unless U.S. government employees, weren’t required to pay personal income taxes. Another major difference between Puerto Rico and other states was the inclusion of public corporations among government entities, such as utilities like Puerto Rico Electric Power Authority (or PREPA), the Puerto Rico Highway and Transportation Authority (or PRHTA), and the Puerto Rico Aqueduct and Sewer Authority (or PRASA). The financials of these entities were included in the government’s balance sheet, unlike the prevailing norm in most states.

Impact of public corporations on Puerto Rico’s debt

Public corporations account for about 40% of the total outstanding debt of Puerto Rico. More importantly, ~85% of the increase in debt-gross national product (or GNP) ratio between 2000–2013, can be attributed to these corporations. The ratio of debt-GNP for Puerto Rico increased from about 60% in 2000, to over 100% in 2013, far exceeding any other state in the U.S. New York has the highest debt-GNP ratio among U.S. states at 29%—less than a third of the debt level in Puerto Rico.

In addition to the public debt, the island must also meet its unfunded pension liabilities, which are a contingent future claim and must necessarily be honored. According to Dr. Dudley, there were three key factors determining the debt burden—the government’s fiscal policy, the growth rate of the economy, and the interest rate on the public debt.

In the following section, we’ll discuss the investor impact of some of these policies, comparing returns on exchange-traded funds (or ETFs) like the Market Vectors High-Yield Municipal Index ETF (HYD), the SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB), and the iShares National AMT-Free Muni Bond ETF (MUB) with returns for the SPDR S&P 500 ETF (SPY) and the Vanguard Total Bond Market ETF (BND). Please continue reading the next sections in this series.

By Phalguni Soni

Must-know: Why is Puerto Rico’s economy unique compared to mainland U.S.?