June 2003 June 2003

3 Economic Growth 4 National Accounts: GDP & GNP 5 Fixed Investment 6 Construction 9 Personal Income 10 Economic Sectors 11 External Trade 12 Employment Household Survey 13 Unemployment 14 Participation Rate 15 Employment Payroll Survey 17 Manufacturing 20 Tourism 23 Inflation 24 Forecast 25 Energy Trends 26 Sensitivity Analysis

2 Real GNP Growth Rate Economic Growth 4.4 4.2 4.1 3.8 3.9 3.5 3.4 3.4 3.3 3.3 3.2 3.0 3.0 2.5 2.5

1.5 1.6 1.0 0.9 0.8 • The international and local environment of instability and uncertainty surrounding the economy intensified in FY02, causing -0.2 a 0.2% decline in real GNP. In the U.S, a recession was declared % Change starting in March 2001. The Business Cycle Dating Committee of the National Bureau of Economic Research, has not yet declared -2.6-2.6 an ending date for that recession. This institution usually declares

0 2 4 6 8 0 2 4 6 8 0 2 the beginning and ending dates of recessions with a lag of various '8 '8 '8 '8 '8 '9 '9 '9 '9 '9 '0 '0 quarters. Fiscal Year

GNP Identity • The economy of Puerto Rico is closely linked to the United States. Except for the price of oil, all other key exogenous variables like exports, direct investment, transfer payments, interest rates, Domestic External inflation, and tourist expenditures depend on the U.S. economy. Demand Sector GNP = C + I + G + (X - M) • The U.S. economy was dragged down by increases in the level of FY 2002 Real Growth Rates interest rate by the Fed in CY99 and CY00, that later was affected -0.2 1.4 -4.1 5.5 -3.0 -0.5 by the aftermath of the September terrorist attacks in CY01. At the same time, the capital market adjustments and the corporate accounting scandals contributed to the deceleration. As a result, consumer as well as business confidence retreated, with side Real Growth in GNP & Domestic Demand effects to the economy of Puerto Rico. (2002 Prices) 6,000 5,000 • The real GNP decline of 0.2% in FY02 was short of the official Domestic Demand forecast made in March 2002, which was 0.3% and –0.1% in the 4,000 GNP 3,000 baseline and pessimistic scenarios, respectively. However, in 2,000 contrast with other periods of recession or deceleration, like fiscal 1,000 years 1982, 1983, 1991 and 1992, the growth in domestic demand stayed positive and slightly above the real GNP growth. Million $ 0 -1,000 -2,000 -3,000 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 Fiscal Year 3 National Accounts: GDP & GNP

Gross Domestic Product • The National Accounts are a series of macroeconomic and Gross Product variables summarized in a set of tables which together give a picture of the performance of the economy as a whole and 80 of some of the important sectors. Two of the most important GNP-GDP* GDP GNP 60 aggregate measures are Gross Domestic Product (GDP) and Gross National Product (GNP). The detailed National 40 Accounts are published annually, on a fiscal year basis, which runs from July 1 to June 30. 20 Billion $ 0 • GDP and GNP are closely related measures. GDP measures the total output of the economy in a period (i.e., the value of -20 work done by employees, companies and self-employed -40 persons). This work generates incomes, but not all of the '57 '62 '67 '72 '77 '82 '87 '92 '97 '02 incomes earned in the economy remain as the property of Fiscal Year residents (and residents may earn some income abroad). The * Net amount of incomes “sent” abroad. total income remaining with Puerto Rico residents is the GNP and it differs from GDP by the net amount of incomes sent to or received from abroad. 70 Puerto Rico’s Adjusted Domestic Income 65 Employees' Compensation • In Puerto Rico’s case, for three decades, the amount paid to 60 Property Income persons abroad has exceeded the amount received from 55 abroad, due mainly to the profits of U.S. and foreign-owned companies, and our GDP is, therefore, higher than our GNP. 50 That amount has grown over the decades, and in FY02 our 45 GDP was 57.4%, or $25.9 billion, higher than the GNP. Percent Share Percent 40 35 • Also, due to the large number of high-tech, capital intensive 30 companies operating in the manufacturing sector, property

6 9 2 5 8 1 4 7 0 3 6 9 2 income (mainly profits of mainland companies) now '6 '6 '7 '7 '7 '8 '8 '8 '9 '9 '9 '9 '0 represents 60% of the Island’s domestic income. Fiscal Year

4 Real Fixed Domestic Investment (2002 Prices) Fixed Investment 14,000 M & E 12,000 Const. 10,000

8,000 6,000 • Fixed investment, composed of construction and machinery and Million $ Million equipment (M&E) investment, was the main driving force behind 4,000 the economic expansion of the second half of the last decade. 2,000 Both of them reached record levels. Real M&E investment showed double digits growth rates in FY 95 and FY97, and in FY99 grew an 0 unbelievable 34.5%. Even more important was the fact that the '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 extraordinary level reached in FY99 was more or less maintained in Fiscal Year the following years, with a small increase in FY00 and only slight Real Construction Value declines in FY01 and FY02.

8,000 (2002 Prices) • Real construction investment advanced at an accelerated pace, 7,000 Private almost doubling in the five years ended with FY99. Both, private 6,000 Public and public investment contributed to the growth. Public 5,000 investment reached its highest point in FY98 and has declined only slightly since then. 4,000

Million $ Million 3,000 • Real private investment also grew at an extraordinarily rapid pace. 2,000 Between FY95 and FY00 it more than doubled, growing 148%. In FY99 it grew 47% due primarily by an extraordinary increase in 1,000 housing investment induced in part by the federal relief funds to 0 repair the damages caused by hurricane Georges. Since then,

'78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 private investment has grown somewhat, offsetting slight declines Fiscal Year in public investment, thus maintaining the overall high level of total real construction investment. The relatively low level of interest Real Investment Share of GNP rates has played an important role in this positive outcome. 35

30 • New government investment projects already started, in process and in the pipeline should maintain and expand the level of public 25 construction investment. Indeed, the official capital improvement program of fiscal years 2003 and 2004 is at record levels. Thus, it is 20 significant, that despite the slow economic growth of the last few

Percent years, construction investment has maintained and is forecast to 15 maintain a high level of investment, thus avoiding the sharp declines of previous periods of economic deceleration or 10 recession, thereby helping to mitigate the severity of the current 5 economic decline. '60 '63 '66 '69 '72 '75 '78 '81 '84 '87 '90 '93 '96 '99 '02 Fiscal Year 5 Construction Real Construction Investment

23.2 19.7

12.2 11.4 • After almost doubling during the five fiscal years ended FY99 7.9 growth of real construction investment growth decelerated 4.9 to 3.0% in FY00. In FY01, it declined by 1.2%, and increased % Change 3.6 2.2 3.0 by 0.3% in FY02. 0.1 0.3

-1.2 -2.7 • Public construction investment, which has been an '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 important contributor to the overall expansion of Fiscal Year construction, stayed unchanged in FY02, after three declines in a row. This was the result of the completion or near completion of large investment projects, such as the urban train and the super-aqueduct, plus the rescheduling Nominal Construction Investment of some construction phases for other key projects to FY03 and beyond.

60 50.3 Total Private Public 50 • The private sector, aided by a low interest rate environment, 40 advanced 1.7% at current prices to $4.3 billion. The 1.7% 25.9 30 22.3 nominal growth in private construction investment in FY02

20 14.2 13.9 was very significant because it maintained the already high

% Change 5.7 4.5 level of private construction investment. In just three yeas, 10 -0.1 1.7 1.1 0.0 FY97 to FY00, private investment more than doubled, 0 -1.9 -1.3 -3.4 growing 116%. As a result, for only the fourth consecutive -10 -7.8 year, and for the fourth time since 1974, the share of private -20 construction activity in FY02 exceeded that of the '98 '99 '00 '01 '02 government (63% to 37%). Fiscal Year

6 Public Construction Investment Construction

.6 95 5

.0 .1 9 78 8 4 4 .4 .2 8 .0 6 3 8 4 1 4 2001 2002 . 9 4 88 7 3 .8 3 . 3 59 • The public investment in key projects has been an important 5 3 3 .6 05 3 component in the strength of construction investment. This .3 .1 43 Million $ Million 21 2 2 has included among others, the urban train and the super-

.1 aqueduct. In recent years, it also included an aggressive 37 .6 1 14 1 .1 3 CIP in water related projects, schools, and housing. 6 5. 4 3

r A A A s g s ls e • Traditionally, housing investment has been the principal P T F ie n n o h E I it si o o t H / l u is h O R R A a o r c segment of private construction activity. As before P P S ip P S A ic H R n P u mentioned, after an extraordinary nominal increase of 42% M in FY99, housing investment not only maintained its high Fiscal Year level but registered further expansions in FY01 and FY02, surpassing the $2 billion mark.

• Besides housing, other key components of private construction investment have been commercial, hotels, Private Construction Investment pharmaceutical, and telecommunication. Two .6 64 ,3 cogeneration plants burning natural gas (Ecoeléctrica) and 4 2 9. 2 ,0 a coal (AES) are already in operation. 2 2001 2002 Million $

9 7 . .4 . 7 45 8 49 . 5 1 .2 5 44 5 1 8 5 9 . .7 3 .1 40 .2 7 .8 01 3 6 8 62 3 .5 25 2 2 2 .2 7 3 9 1 1. 0. 5 1 2

l s g a ls al ls ts r in i te i a n n e s rc o tr c io a th u e s ti t l o H u u ca P O m d e i n H m n c n o o I a u ti C am m ra h m e P co en e g el o T C Fiscal Year 7 Construction

Cement Sales 10.9 8.7 6.6 • Concurrent with the recent slowing of construction growth 4.7 3.5 3.4 as shown in the real construction investment chart on page 2.6 2.9 2.3 1.4 6, the growth in cement sales has decelerated since FY00. 0.6 However, the cumulative figures for the first nine months of % Change FY03 show an increase in cement sales of 3.4%. -1.5 -1.3

-4.7 • The total value of construction permits, another indicator of '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03* trends in construction, also is showing a rebound in FY03. After a 27% decline in FY02, the total value of construction Fiscal Year * Cumulative figures for the first nine months of FY03 (July 02 to March 03). permits increased 26% in the first nine months of FY03. The growth is distributed among industrial, commercial, and residential permits.

Construction Employment 100 • Construction employment, according to the Household Survey, which includes self-employment, has remained 90 Household Payroll more or less flat in the last few years, but at a relatively high 80 level of employment. However, the results of the new benchmark revision of the Payroll Survey showed that the 70 sector lost payroll jobs in FY02 and during the first nine

Thousands months of FY03. 60

50

40

II I II II I V II I II II I I II 4 I 7 I I II 0 I 3 2 3 9 4 IV 5 6 9 7 8 9 0 0 IV 1 2 0 9 9 9 9 9 9 9 9 0 0 0 Quarters

8 Personal Income Personal Income 45 (2002 Prices) 40 Federal Grants 35 Other Income * 30 Income from Production 25 20 Billion $ 15 • Income derived from production activities (mainly 10 employees' compensation) rose 2.8% in FY02. Income from 5 production activities was responsible for 68% of total 0 personal income in that same year. '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 Fiscal Year * Includes federal & local earned benefits. • Federal transfers to persons reached $8.9 billion in FY02. This amount represented an increase of $316.3 million, or 3.7% Federal Transfer to Persons over the FY01 numbers. Social Security benefits provided 2002 97% of that growth. Indeed, in the last three fiscal years, Social Security benefits grew by more than one billion dollars, the equivalent of a 31% increase. Earned N.A.P. 55.4% Other Benefits 24.2% 75.8% Scholarships 16.2 % • Earned benefits, like Social Security, Medicare and Veterans’ benefits, amounted to 75.8% of federal transfers Other 28.4% $6,767 MM to persons, and grants made up the balance. Grants $2,155.2 MM consist primarily of transfers through the Nutritional Total $8,922.2 MM Assistance Program (former food-stamp program) and Change of Federal Transfers scholarships (Pell Grants). to Persons 14.0 12.3 11.7 10.2 10.0 9.3 9.6 9.4 8.2 7.6 6.7 6.7 6.7 5.4 5.5 4.6 4.0 3.4 3.5 3.7

% Change 3.3 2.8 1.3 1.2 0.0

78 80 82 84 86 88 90 92 94 96 98 00 02 ' ' ' ' ' ' Fiscal' Year' ' ' ' ' ' 9 Net Income by Economic Sector Economic Sectors Fiscal Year (Percent Share)

1980 2002 %% • Total net domestic income grew 3.2% to $61.5 billion in FY02. Agriculture 3.5 1.0 Manufacturing net income, which in FY01 grew an Construction 2.7 2.6 outstanding 21%, as a result of strong growth in exports, Manufacturing 38.4 45.7 increased another 4%, in nominal terms, in FY02. Mining 0.1 0.1 Government 15.3 10.2 • The slow growth in manufacturing net domestic income in Total Service 39.9 40.5 FY99 and FY00 apparently is related to the conversion to TCPU 8.3 5.7 Controlled Foreign Corporations (CFC) of key Trade 13.0 9.8 manufacturing companies. Under the new corporate FIRE 9.7 15.0 scheme, manufacturing companies pay royalties to their Service 9.0 10.0 parent companies and a 10% tax to the local Treasury Department. As a result of these conversions, this amount of funds represents a cost for the company instead of a profit. Non-Farm Payroll Employment by Economic Sector • Services continue to dominate the job market. In FY02, its Fiscal Year combined share of payroll employment increased to 51.7% (Percent Share) from 51.5% in FY01. The government share of total payroll employment has continued to decline. In FY00 it dropped below 30% of total employment, and in FY02 stood at 27.9% 1980 2002 of non-farm payroll employment. %% Construction 5.5 7.1 • In addition to its role in generating income and jobs, key Manufacturing 22.7 13.1 activities within the services sector are an important Mining 0.1 0.1 counter-cyclical force during the downside of the business Government 36.4 27.9 cycle. Total Service 35.2 51.7 TCPU 2.5 3.3 Trade 16.6 21.8 FIRE 3.9 4.7 Service 12.2 21.9 10 Economic Classification External Trade Adjusted Merchandise Imports 40

35 Consumer Goods 30 Capital Goods 25 Other Raw Materials Petroleum 20 • Puerto Rico imports most of the raw materials and 15 petroleum products needed for production and Billion $ Billion 10 consumption. The growth of manufacturing exports 5 explains the strong increase in raw materials imports, a 0 nominal increase of 82.4% in the last five fiscal years (FY97 to '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 FY02). Fiscal Year Recorded Exports Growth • Since FY97, recorded exports have almost doubled, with a 26.4 cumulative increase of 97%. After a pause in FY02, exports 21.9 continued growing in FY03, with a 15.1% increase in the first 17.2 18.0 15.4 15.3 15.6 15.3 15.1 nine months of the fiscal year.

10.5 9.8 9.8 9.9 9.5 10.2 7.3 • Pharmaceutical exports have been the driving force behind 4.3 4.4 total exports growth. In just four years, drug exports have 0.6

% Change more than tripled, from $8.3 billion in FY97 to $31.1 billion in -1.3 FY02. Antidepressants, tranquilizers, and antibiotics have -4.1 -3.6 -6.0 been at the top of the list.

'81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03* • Petroleum imports have declined in the last two fiscal years, Fiscal Year * Cumulative figures from July to March 2003. as a result of a slower economy, more efficiency in the use of energy and the phase-in of operations of two electricity Recorded Merchandise Trade cogeneration plants, one burning natural gas and the other 60 coal. 50 Exports 40 Imports 30 Trade Balance 20 10

Billion $ Billion 0 -10 -20 -30 -40 '81 '84 '87 '90 '93 '96 '99 '02 Fiscal Year 11 Employment Household Survey Total Employment (S.A.) 1,250

1,150 • In FY02, total employment, according to the Household Survey, grew 1% to 1,169,600, for a gain of 11,700 jobs from 1,050 FY01.

950 • The Household Survey, which includes self-employment, has 850 increased by 3.3%, or 38,700 jobs, in the first nine months of Thousand FY03, which is the highest annual increase for the first nine 750 months of a fiscal year since FY97. If this trend continues, it 650 should have a positive impact on FY03 overall growth.

I I I I I I I I I I I I I I I I 0 II 3 II 6 II 9 II 2 II 5 II 8 II 1 II 8 1 8 4 8 7 8 0 9 3 9 6 9 9 0 2 8 8 8 9 9 9 9 0 03 I • The Household Survey’s total employment has followed a Quarter long-term expansion trend. Total employment, according Total Employment to the Household Survey, increased from 976,900 in FY90 to 12 (Year-Over-Year Percent Change) 1,200,300 in the first nine months of FY03. The annual 10 compound growth rate has averaged 1.6% over the last 8 thirteen years. The annual growth rate accelerated to 3.7% 6 during FY95 to FY97 and then fell to 0.7% between FY97 and 4 FY02. The growth rate rebound to 3.3% during the first nine 2 months of FY03. 0 Percent -2 -4 -6 -8

I V II II I V II II I V II II I V 0 I I 5 7 I I 2 4 I I 9 1 I I 8 1 3 8 8 8 0 9 9 5 7 9 0 2 3 8 8 8 9 9 9 0 0 Quarters

12 Unemployment

Unemployment Rate (S.A.) 26

24

22 • As economic activity slowed during FY02, unemployment

20 rose with the unemployment rate rising 1.5 points, up from 10.5% in FY01 to 12.0% for FY02. 18

16

14 • An above average increase in the non-institutional civilian Percent population 16 years and over, combined with an increase in 12 the participation rate explains some of the growth in 10 employment and unemployment in FY02 and in the first nine 8 months of FY03. I I I I I I I I I I I I I I I I 0 II 3 II 6 II 9 II 2 II 5 II 8 II 1 II I 8 1 8 4 8 7 8 0 9 3 9 6 9 9 0 2 8 8 8 9 9 9 9 0 03 Quarter • Over the last 20 years, Puerto Rico’s unemployment rate has declined by about 50% and, despite a recent reversal corresponding to the slowing economic activity, is at a long-term low. Unemployment Rate (Year-Over-Year Percent Change) 30

20

10

0 Percent -10

-20

-30

I V II II I V II II I V II II I V I 0 I I 7 I I 4 I I 1 I 8 1 3 5 8 8 0 2 9 5 7 9 0 2 3 8 8 8 8 9 9 9 9 9 0 0 Quarters 13 Participation Rate

50 Participation Rate

48 • The participation rate shows the percentage of the working 46 age population that is part of the labor market, either employed or unemployed. In FY02, the participation rate Percent 44 was 45.8%, up slightly from 45.4% in FY01. After hitting a 10 year low of 45%, the rate has begun to trend upward. The average rate of the first nine months of FY03 shows further 42 growth in this key indicator, caused in part by an increase in female participation. 40

I II II I I I I I 0 IV 5 I IV I III IV 5 II III IV 0 II III I 8 81 3 8 86 8 90 I 91 2 3 9 96 7 8 0 01 2 • The counterpart of the participation rate, called the 82 I 8 87 III 8 9 9 9 9 0 03 Quarters employment rate, is the number of persons employed divided by the non-institutional civilian population 16 years Participation Rate by Sex and over. For FY02 that rate was 40.3%, down from a record (Three months moving average) level of 41.7% in FY97. However, the cumulative figures for 64 40 FY03, up to march, show a slight increase after five 63 38 consecutive declines since FY97. 62 36 61 34 • More important than these numbers, is the sharp decline in the participation rate of the male population that has 60 32 occurred since FY98. The drop of four percentage points in 59 30 just four years is almost unprecedented and despite a % (Male) 58 28 % (Female) leveling off during the first nine months of FY03 it represents a 57 Male Female 26 real challenge for policy planners to reverse. 56 24

I I I I I I I I I II I IV II I 6 IV II I 3 5 7 9 0 2 4 9 7 9 1 0 8 8 8 9 9 9 9 9 0 Quarter

14 Employment 4 Payroll Employment Benchmark Revision 3 Payroll Survey 2

1

0

-1 • With the release of payroll employment estimates for January 2003, the Puerto Rico Labor Department Percent Revision Percent U.S. 2002 preliminary -2 incorporated the March 2002 benchmarks and converted -3 the data to conform to the 2002 North American Industry '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 Classification System (NAICS). These changes affect data As of March analysis and comparison, primarily at the industry level. Total U.S. Highest state downward revision P.R. Adjusted Payroll Employment • The same changes were implemented in the U.S as part of a 50 (Year-Over-Year Absolute Change) 40 Federal-State cooperative program, known as the Current Employment Statistics (CES), that produces monthly 30 Government ** Private estimates of payroll employment. CES estimates are among 20 the most closely watched and widely used economic 10 indicators by U.S. public and private policymakers. 0 -10

Thousands -20 • With the release of data for January 2003, the sample -30 based estimates have been adjusted to new benchmarks – -40 comprehensive counts of employment – based primarily on -50 unemployment insurance tax records filed by employers in 92 I 93 I 94 I 95 I 96 I 97 I 98 I 99 I 00 I 01 I 02 I 03 I P.R. and the U.S. with State Employment Security Agencies. Quarter The revisions incorporate March 2002 benchmarks and Adjusted Payroll Employment affect data from 2001 forward. 6 (Year-Over-Year Percent Change) 5 • As shown in the first graph, and according to the 4 methodology and the experience with the Payroll Survey, 3 during periods of economic expansion those revisions mean 2 an improvement over the preliminary report. During periods 1 of contraction or low growth, those revisions mean only a 0 Percent small improvement or decrease over the preliminary report. -1 Puerto Rico** -2 United States Line 3 -3 -4 91 I 92 III 94 I 95 III 97 I 98 III 00 I 01 III 03 I ** Excludes government summer job programs. Quarter 15 Employment

Payroll Employment (S.A.) Payroll Survey Indexes 102

100 • The first graph shows how payroll employment behaved 98 during the recession of fiscal years 1982 and 1983, the growth pause of fiscal years 1991 and 1992, and during the 96 most recent recession in Puerto Rico. The blue line shows 94 that during the recession of 1982-1983, it took the economy 47 months to regain the pre-recession level of payroll 92 employment. The gold line shows that during the growth pause of 1992 and 1993, it took a little over 2 years to reach 90 pre-recession levels of payroll employment.

-5 -2 1 4 7 0 3 6 9 2 5 8 1 4 7 0 3 6 1 1 1 1 2 2 2 3 3 3 4 4 4 • The current decline in the payroll employment indexes of Economic Cycles the first graph (red line), is somewhat deeper than the Oct 80 - Sep 84 Aug 90 - Mar 92 Oct 00 - Apr 03 experienced during the growth pause of 1991 and 1992. 1980m10=100 1990m8=100 2000m10=100 But it also shows that it was less deep than the recession of 1982 and 1983.

Payroll Employment (S.A.) Indexes • The monthly data also suggest that we have already hit 102 bottom and are going through a turnaround. All these Puerto Rico and United States figures already incorporate the January 2003 release of the 100 benchmark revision for March 2002, which affects data from 2001 forward. 98

96 • The second graph shows that in a comparison with the U.S., Puerto Rico began the slowdown five months before and it 94 has lost proportionally more jobs than the U.S. This could be tied to the structural problems of the Island’s manufacturing 92 sector, which has lost a significant amount of jobs in the last few years, primarily in labor intensive industries. 90

9 5 1 3 7 1 5 9 3 7 - - - 1 1 1 2 2 Economic Cycles PR: Oct 00 - Apr 03 US: Mar 01 - Apr 03 2000m10=100 2001m3=100 16 Manufacturing Gross Domestic Product by Economic Sector (Percent Share) Other Govt. Other 8.2% 16.5% 8.9% Mfg. 23.6% • Manufacturing remains a major force behind the economy. Govt. 12.1% Mfg. The share of manufacturing in Gross Domestic Product in 42.2% FY70 was 23.6%. By FY02, manufacturing accounted for Const. Serv. 42.2% of GDP. 7.5% 38.2% Const. Serv. 2.6% • In terms of net domestic income, the chemical industry is 197040.2% 2002 the cornerstone of the manufacturing sector, with a 63.7% Manufacturing Net Domestic Income 30,000 share. In FY02, the industry’s net domestic income grew by Industrial Activity 6.5% in line with the 8.3% nominal increase in chemical 25,000 Other exports in FY02. Food 20,000 Apparel • Due to the large number of capital intensive industries in the 15,000 Machinery Chemical manufacturing sector, total property income (mainly profits) has increased at a rate faster than total employees’ Million $ 10,000 compensation. This is “indicative” of a significant growth in 5,000 manufacturing productivity.

0 '60 '70 '80 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 Fiscal Year Manufacturing Net Income 400 350 Employees' Compensation 300 Proprietors' Income 250 200 150

Index 1980=100 Index 100 50 0 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 Fiscal Year 17 Manufacturing Employment (S.A.) 170 Manufacturing 160 150 140 130 • As in the U.S., manufacturing employment was especially Thousands 120 hard hit by the recent recession. Employment lost in this 110 sector came primarily from labor intensive textiles, apparel, leather and canned tuna. I I I I I I I I I I I I I 5 II 8 II 1 II 4 II 7 II 0 II 3 8 6 8 9 9 2 9 5 9 8 0 1 0 8 8 9 9 9 0 • Mixed employment results occurred in electronics and Quarter instruments due to some labor-intensive operations similar to 15 Manufacturing Employment (Year-Over-Year Absolute Change) apparel and volatile, short product life cycles, but high 10 value-added operations are expanding. 5 0 • While labor intensive manufacturing continues its downward -5 trend, most high-tech manufacturers are expanding their operations as Controlled Foreign Corporations (CFC). The -10 Thousands pharmaceutical industry, for instance, recorded a 6.9% and -15 6.3% increase in employment in CY01 and CY02, -20 respectively, the highest growth rates in many years. The 88 I 89 III 91 I 92 III 94 I 95 III 97 I 98 III 00 I 01 III 03 I comparative rates for the U.S. were 2.6% and 2.7% in the Quarter Manufacturing Employment same period. (Year-Over-Year Percent Change) 10 • The pharmaceutical industry is an anti-cyclical industry 5 which always has shown great resilience during the downside of the business cycle. This industry, which has 0 developed blockbuster drugs and technology to maintain -5 its global competitiveness, has been the driving force of the Percent P.R. growth in exports in the last few years. -10 U.S. -15

I I I I I I I I I I I I I 5 II 8 II 1 II 4 II 7 II 0 II 3 8 6 8 9 9 2 9 5 9 8 0 1 0 8 8 9 9 9 0 Quarter 18 128 120 107 Plant Shutdowns Manufacturing 101 99 94 98 88 78 78 76 74 69 68

Number 25 • In FY01, there were 76 plant shutdowns. Total jobs lost amounted to 4,156. In FY02, a total of 2,498 jobs were lost 9 0 1 2 3 4 5 6 7 8 9 0 1 2 r. '8 '9 '9 '9 '9 '9 '9 '9 '9 '9 '9 '0 '0 '0 a M from 73 plant shutdowns, a significant reduction in lost - l. Ju employment that continues into FY03. In the first nine Fiscal Year months of FY03, there were 25 plant shutdowns with a total Recorded Exports Growth 26.4 job loss of 464.

21.9

17.2 18.0 15.4 15.3 15.6 15.3 15.1 • Despite the drop in employment, total manufacturing

10.5 production remained strong as reflected in export growth. 9.8 9.8 9.9 9.5 10.2 7.3 Merchandise exports, primarily from the pharmaceutical 4.3 4.4 industry, have grown significantly since FY97. Occurring 0.6

% Change without large employment gains, this performance -1.3 “suggests” an extraordinary increase in manufacturing labor -4.1 -3.6 -6.0 productivity.

'81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03* Fiscal Year * Cumulative figures from July to March 2003. US Industrial Production Index Pharmaceutical & Medicines (Year-Over-Year Percent Change) 15 Forecast 10

5 Percent 0

-5

I I I I I I 6 I II IV 1 I II IV 9 7 8 9 0 2 3 4 9 9 9 0 0 0 Quarter 19 Tourism

Number of Visitors

Other Places Excursionists In hotels • When measured in terms of direct expenditures by non- residents tourists, tourism represents a small segment of the 1,186.8

1,013.8 economy. The current 5.5% share of GNP suggests that 1,050.1 942.4 809.5 1,147.8 697.2 861.6 1,042.0

679.5 tourism activity has a relatively small impact on general 644.9 economic activity. However, its importance is much 1,356.6 1,274.7 980.2 1,224.6 955.9 1,107.9 1,045.1

1,014.5 greater, in terms of employment and income multipliers, Thousands 1,197.2 1,277.0 1,073.4 than what this figure would suggest. Nonresident as well as resident expenditures in tourism activities provide links, directly and indirectly, to such economic activities as 2,382.4 2,364.4 2,345.2 2,321.2 2,299.4 2,291.3 2,175.0 2,203.4 2,011.7 1,982.1 1,939.3 transportation, communications, trade, service, restaurants, entertainment, and many others. '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 Fiscal Year • Throughout the last decade Puerto Rico experienced consistent growth in the number of visitors coming to the island. Up to FY02, the average annual growth rate has been 1.6%. This growth is fundamentally due to tourist Visitor Expenditures lodging in hotels, which has grown 5.9% annually during this 2.7 2.5 period. The only years where this was not true were FY99 2.4 2.2 and FY02, due to the effects of Hurricane Georges and the 2.1 2.0 recent recession, respectively. In spite of these events, the 1.9 1.8 1.7 number of US visitors coming to the island remains strong. 1.6 1.5 Over 4 million visitor arrivals were recorded during FY02, 71% were tourists and 37% of these made their lodgings in the island’s hospitality industry. Approximately, 90% of tourists Billion $ Billion staying in hotels came from the US.

• Over 90% of visitors expenditures can be classified as tourist related. This illustrates the importance of non resident land '92'93'94'95'96'97'98'99'00'01'02 Fiscal Year base expenditures to the island's tourism sector.

20 Total Rooms Inventory Tourism 13,932 13,497 12,778 12,353 11,928 11,848 11,102 10,869 10,265 10,251 9,519 8,581 8,415 Number

• From FY92 to FY00 the total stock of rooms grew from 8,415 to 11,928, an average increase of 4.5% per year. 2,536 new tourist rooms were added, amounting to 72.8% of the total new rooms. This translated into an increase of approximately 5.0% in tourist '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 room availability. Most of the increase came from the opening of Fiscal Year major hotel chains such as Westin Río Mar, Embassy Suites, San Tourist Hotel Registrations Juan Colony, The Wyndham Old San Juan, Hampton Inn and the Ritz Carlton, which together added more than 2,250 rooms. Since FY00 the yearly increase in inventories has been around 3.5%, and 1,603 1,601 over 400 units have been added to the stock of tourist rooms. 1,450 1,431 1,374 1,261 1,210 • In spite of this expansion, the overall occupancy rate at tourist 1,115 991

925 hotels during this period has been, on average, around 70%. When

842 measured by room occupancy, the demand for lodging in tourist Thousands hotels outpaced growth in room availability by 1.0%. In terms of tourist room registrations, the demand has grown even faster, 7.0% annually during the same period. Over 70.0% of those registrations are by non residents.

'92'93'94'95'96'97'98'99'00'01'02 Fiscal Year • The long run trend in new hotel construction is expected to Tourist Hotel Construction for Fiscal Year 2003-05 continue, although not at the same pace as the decade before. As of February 2003, new additions to the total supply of lodging Beginning Approximate Num. of facilities amount to 669 rooms. The recent reopening of Marriott Hotel Location Year of Costs Rooms Courtyard (formerly Crowne Plaza) in Isla Verde and the formal Operations (millions) opening of Martineau Bay Resort (construction ended two years Costa del Sol Aguadilla 160 March 2003 $365 ago) have added 411 tourist rooms, 61.4% of the new additions. Still under construction is the Hotel Sol Melia, part of one of Casa Bonita Culebra 164 March 2003 20 Europe’s largest hotel chains and the first all-inclusive resort on the Cayo Largo Intercontinental Fajardo 314 April 2003 119 Island which will add more than 490 rooms to the island’s inventory. Caguas Hampton Inn Caguas 125 June 2003 30 Also under construction are Cayo Largo Resort, Caguas Hampton Inn, Condado Lagoon Villas, Costa Bonita, Costa Caribe (Ponce Paradisus-Sol Meliá Río Grande 490 Nov. 2003 147 Hilton) and Legado Resort which are expected to add a total of Ponce Hilton (Expansion) Ponce 100 March 2004 16 1,646 new rooms. Condado Beach Trio San Juan 319 Nov. 2004 183 King's Palace Resort Aguadilla 110 Dec. 2004 11 Condado Lagoon Villas San Juan 264 Dec. 2005 39 Fairmont Resort Río Grande 412 May 2005 158 21 Legado Resort Guayama 189 June 2006 105 Tourism

Daily Occupancy Rates

FY2002 FY2003 • According to the current daily hotel occupancy survey (designed to measure short term trends), the island’s overall

85% occupancy rates show the same level than last year’s 81% 80% 79% 78% 76% 74% 74% 74% comparable figures. Although daily occupancy rates 70% 70% 69% 67% 66% 65% (DOR) tend to be slightly higher than the actual monthly 61% 58% occupancy rates, during the first nine months (July through 48% March) of the present fiscal year, DOR averaged 80%. For FY02 the rates for the comparable months averaged 81%. Both DOR rates are fairly high, particularly when we consider the uncertainty that has prevailed in the travel July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. market since the events of September 2001 and the possible adverse consequences of the war with Iraq.

Hotel Room Occupancy • The present high season (December through April) will FY2002 FY2003 190 probably show a higher room occupancy then the previous 177 178 175179 high season. Up to February 2003, room occupancy had 168 170 164 154 160 159 156 148 grown 11.8% while rooms available were up by 4.1%. The 144 144 132 128 DOR rate stood at 76.6%.

101 Thousands

July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar.

22 Consumer Price Index Inflation (Year-Over-Year Percent Change) 10 Puerto Rico United States 8

6 • A growing trend in consumer price rises with annual rates in 4

Percent excess of 5%, even at a 9% level just a few quarters ago, has 2 come to a halt in the last few months. The divergence from price trends in the U.S. persisted for six fiscal years. For the 0 first time since FY95, inflation increased around the 4% level 91 I 92 III 94 I 95 III 97 I 98 III 00 I 01 III 03 I in FY02. Quarter Consumer Price Index by Principal Category • The main reason for this divergence has to do with the fact Transportation (Year-Over-Year3.4 Percent Change) that the market basket of goods and services used to estimate changes in prices is based on the 1977 Study of Medical Care 3.5 Income and Expenditures of Families. This system of weights has become outdated and, we believe, has significantly Housing 2.0 overstated the overall movements of the CPI, given the changes in consumer consumption patterns that have Food & Beverages 13.6 occurred over the last two decades. A new government Educ. & Recre. 1.2 funded Study of Income and Expenditures is now underway at a cost of $4 million. The study was expected to be Apparel -0.9 finished by the end of CY01, but delays have moved the ending date to this summer. % Ch. (Jul. - Mar. 2003) Consumer Price Components’ Relative16.6 Importance • Instability and uncertainty in the energy front continue to Other 6.2 7.2 put upward pressure on oil prices. Entertainment 3.4 16.7 Medical Care 6.8 12.1 Transportation 14.0 7.4 Apparel 4.1 PCE 2/ 10.9 CPI 1/ Household Operation 11.4 11.4 Shelter 17.0 17.7 Food & Beverages 48.5 1/ June 2001 * Estimated with January and February figures. 2/ Fiscal Year 2001 % Change 23 Real GNP Growth Rate Forecast 4.6 4.3 4.1 4.1 P.R. 4.0 3.6 3.4 3.4 3.2 3.3 3.3 3.3 U.S. * 3.2 3.1 3.0 2.9 2.8 2.6 2.5 2.5 2.5 1.8 1.7 1.6 1.2 0.9 0.8 % Change 0.7 • The Planning Board, the agency that prepares the official 0.1 economic forecast, is projecting slow recovery in FY03.

-0.2 According to the Board, growth for FY03 should be around '90 '92 '94 '96 '98 '00 '02 '03 * Global Insight Inc. 3/03. Fiscal Year 1.7%. Following the U.S. economic trend, in FY04, economic Macroeconomic Variables1. 7 for GNP Forecast growth should rebound to 2.5%. GNP 2.5 (February 2003)

Personal 2.7 • The major risks in the near term are: the length of the war in Consumption 3.8 Iraq, further terrorist attacks, increases in oil prices beyond those already forecast, and a decrease in total recorded 9.0 Con s tru ction exports, which could affect the leading role that the In ve s tm e n t 6.0 external sector has played in the last few years. If this M & E 7.3 occurs, then the domestic demand (i.e., personal In ve s tm e n t 6.5 2003 consumption expenditures, fixed capital investment, and 2004 government expenditures) will have to fill the void of the Personal 2.7 In c om e 3.8 external sector in order to avoid further economic declines.

% Change Exogenous Variables for GNP Forecast 2.8 (February 2003) U.S. Real GDP (% ch.) 4.4

4.0 Adjusted Merchandise Exports (% ch.) 7.4 7.6 Visitors' Expenditures (% ch.) 2003 8.6 2004 5.8 Federal Transfers to Persons (% ch.) 5.7

4.4 Prime Rate (%) 5.5 24.6 Oil Price ($) 22.5

% Change 24 Energy Trends

40 Energy Bill Oil Prices 20 35 18 17.8 16.6 16 30 14 12 25 10 10.6 8 7.1 20 5.2 5.2 6 6.2 5.8 5.5 5.1 5.5 4.9 DRI 4 4.6 4.4 4.7 4.0 3.3 4.2 15 Forecast 2 Dollars per Barrel Mar. ‘03 Cents per dollar GNP of 0 10 '70'75'80'85'89'90'91'92'93'94'95'96'97'98'99'00'01'02 8 2 6 0 4 8 2 6 Fiscal Year '7 '8 '8 '9 '9 '9 '0 '0 Fiscal Year Refinery Acquisition Cost West Texas Average Price of Puerto Rico's Crude Petroleum Imports

Electric Generation in Megawatts Energy Intensity Ratio 28 0.0 0.0 48.4 26 100% 1,155.1 24 2,705.1 3,045.7 22 Puerto Rico 80% 20 United States 18 60% AES 16 EcoEléctrica 20,306.3 19,427.1 19,468.2 14 40% PREPA 12 10 20% 8 0% '70 '75 '80 '85 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 Thou. of Btu's per 1996 dollar of GNP '00 '01 '02 Fiscal Year 25 Sensitivity Analysis

Impact of the Growth of the United States GNP and Oil Prices on the Puerto Rico GNP Growth Rate March 2003

US GNP Growth (%)

Oil Price 0.0 0.6 1.1 1.6 2.1 2.6 3.1 3.6 4.1 4.6 5.1 5.6 6.1

11.00 1.94 2.40 2.79 3.17 3.56 3.94 4.32 4.71 5.09 5.48 5.86 6.24 6.63 12.00 1.74 2.20 2.59 2.97 3.36 3.74 4.12 4.51 4.89 5.28 5.66 6.04 6.43 13.00 1.54 2.00 2.39 2.77 3.15 3.54 3.92 4.31 4.69 5.07 5.46 5.84 6.23 14.00 1.34 1.80 2.18 2.57 2.95 3.34 3.72 4.10 4.49 4.87 5.26 5.64 6.02 15.00 1.14 1.60 1.98 2.37 2.75 3.13 3.52 3.90 4.29 4.67 5.05 5.44 5.82 16.00 0.94 1.40 1.78 2.16 2.55 2.93 3.32 3.70 4.08 4.47 4.85 5.24 5.62 17.00 0.73 1.20 1.58 1.96 2.35 2.73 3.12 3.50 3.88 4.27 4.65 5.04 5.42 18.00 0.53 0.99 1.38 1.76 2.15 2.53 2.91 3.30 3.68 4.07 4.45 4.83 5.22 19.00 0.33 0.79 1.18 1.56 1.94 2.33 2.71 3.10 3.48 3.86 4.25 4.63 5.02 20.00 0.13 0.59 0.97 1.36 1.74 2.13 2.51 2.89 3.28 3.66 4.05 4.43 4.81 21.00 -0.07 0.39 0.77 1.16 1.54 1.93 2.31 2.69 3.08 3.46 3.85 4.23 4.61 22.00 -0.27 0.19 0.57 0.96 1.34 1.72 2.11 2.49 2.88 3.26 3.64 4.03 4.41 23.00 -0.47 -0.01 0.37 0.75 1.14 1.52 1.91 2.29 2.67 3.06 3.44 3.83 4.21 24.00 -0.68 -0.22 0.17 0.55 0.94 1.32 1.70 2.09 2.47 2.86 3.24 3.62 4.01 25.00 -0.88 -0.42 -0.03 0.35 0.73 1.12 1.50 1.89 2.27 2.65 3.04 3.42 3.81 26.00 -1.08 -0.62 -0.23 0.15 0.53 0.92 1.30 1.69 2.07 2.45 2.84 3.22 3.61 27.00 -1.28 -0.82 -0.44 -0.05 0.33 0.72 1.10 1.48 1.87 2.25 2.64 3.02 3.40 28.00 -1.48 -1.02 -0.64 -0.25 0.13 0.51 0.90 1.28 1.67 2.05 2.43 2.82 3.20 29.00 -1.68 -1.22 -0.84 -0.46 -0.07 0.31 0.70 1.08 1.46 1.85 2.23 2.62 3.00 30.00 -1.89 -1.43 -1.04 -0.66 -0.27 0.11 0.49 0.88 1.26 1.65 2.03 2.41 2.80 31.00 -2.09 -1.63 -1.24 -0.86 -0.47 -0.09 0.29 0.68 1.06 1.45 1.83 2.21 2.60 32.00 -2.29 -1.83 -1.44 -1.06 -0.68 -0.29 0.09 0.48 0.86 1.24 1.63 2.01 2.40 33.00 -2.49 -2.03 -1.65 -1.26 -0.88 -0.49 -0.11 0.27 0.66 1.04 1.43 1.81 2.19 34.00 -2.69 -2.23 -1.85 -1.46 -1.08 -0.70 -0.31 0.07 0.46 0.84 1.22 1.61 1.99 35.00 -2.89 -2.43 -2.05 -1.67 -1.28 -0.90 -0.51 -0.13 0.25 0.64 1.02 1.41 1.79 36.00 -3.10 -2.63 -2.25 -1.87 -1.48 -1.10 -0.71 -0.33 0.05 0.44 0.82 1.21 1.59 37.00 -3.30 -2.84 -2.45 -2.07 -1.68 -1.30 -0.92 -0.53 -0.15 0.24 0.62 1.00 1.39 38.00 -3.50 -3.04 -2.65 -2.27 -1.89 -1.50 -1.12 -0.73 -0.35 0.03 0.42 0.80 1.19 39.00 -3.70 -3.24 -2.86 -2.47 -2.09 -1.70 -1.32 -0.94 -0.55 -0.17 0.22 0.60 0.98 40.00 -3.90 -3.44 -3.06 -2.67 -2.29 -1.90 -1.52 -1.14 -0.75 -0.37 0.02 0.40 0.78 -2.11 -1.72 -1.34 -0.95 -0.57 -0.19 0.20 0.58 41.00 -4.10 -3.64 -3.26 -2.87 -2.49 26