February 16th, 2016
This week we review the most recent value of the Puerto Rico Economic Activity Index and examine issues related to its value as an indicator.
Under the Covers of the Puerto Rico Economic Activity Index
Last week the Puerto Rico GDB released the December value for its Economic Activity Index. According to the GDP, the index is designed to be “a coincident index for the economy of Puerto Rico.”
Included in each monthly release of the EAI is a chart comparing actual real GNP growth rates, with the growth rates predicted by the EAI.
Source: Puerto Rico GDB, Puerto Rico Planning Board
The GDB observes that there is a “high correlation” between the two series. The GDB also states that the EAI has value “as an indicator of economic activity, although not as a measure of real GNP.”
Perhaps this is an acknowledgement that large portions of economic activity in the Commonwealth are not captured in official statistics or perhaps it’s an indication that official statistics are not always reliable. We will leave it to our readers to decide whether it is the EAI components or the GNP calculation that is most reliable.
Displaying the actual growth rates vs. predicted growth rates in a scatter plot highlights the periods when the EAI was a particularly bad predictor of real GNP. (The dotted line represents real GNP change equal to EAI change).
The EAI generally understated the rate of decline in real GNP during the years of the financial crisis. More recently it overstated the rate of decline. For 2014, the EAI predicted a drop of -2.20%. The actual decline in real GNP was -0.90%
The year over year change for the EAI for December of ’15 was -0.55%.
The decline in December was the first in four months. The employment (+0.30%); electric power (+2.40%); and gasoline (+0.80%) components were all positive. The cement sales (-14.90%) component was down dramatically.
A dramatic drop in cement sales with only a slight impact on the overall EAI is a pattern we have noticed before. The GDP overhauled the EAI last year, but did not provide any details on its methodology and weighting.
Maybe the weight of cement sales in the index is small. Cement sales have been declining for years. Perhaps the EAI components are calibrated by comparing current values to long-term trends.
Evaluating index components vs. a trend might explain why recent large declines in cement sales seem to have only limited impact of the overall value of the EAI.
Of the four EAI components, only changes in payroll employment seem to correlate with changes in the EAI.
While the attention of most followers of Puerto Rico is focused on legal and legislative developments, the economic health of the Commonwealth remains a critical factor in resolving the crisis. This is particularly true if the “Growth Bonds” proposed by the Commonwealth are part of an ultimate solution.
Have a great week,
Michael Craft, CFA