Restructuring an island’s economy: the case of Puerto Rico

Restructuring an island’s economy: the case of Puerto Rico
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Ricardo Rosselló, the newly appointed Governor of Puerto Rico, treads deep water as he attempts to navigate an ever-worsening fiscal crisis in the Island of Enchantment. He assumed office with a promise to restructure Puerto Rico’s $70 billion debt, following a hostile few years between the island’s representatives and bondholders. To Puerto Rico’s citizens, Rosselló pledges to institute bold reforms, while allowing Washington to continue playing a large role in fiscal oversight.

The crisis in context

Since 2006, Puerto Rico’s economy has been trapped in a deep chasm of depreciation. Matters were made worse post-2015, after failure to meet several bond payments resulted in numerous debt defaults. Hope for a solution was presented with the passing by the U.S. Congress of the Puerto Rico Oversight, Management, and Economic Stability Act, effective June 30th, 2016. Also known as Promesa, the Act established “an Oversight Board to assist the Government of Puerto Rico, including instrumentalities, in managing its public finances, and for other purposes.” Designed to help with the restructuring of the island’s debt, while preventing creditors from suing in the event of bond payment defaults, Promesa has since garnered considerable opposition. Major protests to the Act have opposed the implementation of a fiscal policy which has seen considerable reductions in government spending in the territory. One controversial measure has reduced the minimum wage from $7.25 to $4.25 for workers under the age of 25.

The Gross National Product (GNP) is one of the chief measures used to gauge the health of an economy. A BMI research report estimates that Promesa will take years to return Puerto Rico to a fiscally sustainable position, and that the island’s GNP will continue to contract at an average rate of 0.7 percent from 2016 to 2020. Puerto Rico’s projected negative progression mirrors the trend from the previous five years.

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At a micro level, as the oversight board continues to enforce austerity measures, many Puerto Ricans will likely suffer in the short-term. A rapidly declining population, coupled with an unemployment rate that finished the 2016 fiscal year at 12.1 percent, offers the pessimist observer fuel for an apocalyptic vision. Compare the 46.2 percent of Puerto Ricans who live below the poverty line to the corresponding 14.8 percent in the United States mainland, according to data provided by the U.S. Census Bureau. An effective and widespread job creation program would go a long way to stimulating a depressed economy and raising Puerto Rico’s citizens out of poverty. It remains to be seen if continued austerity measures under Governor Rosselló’s administration will prove positive on this front.

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As an offshoot of the island’s fiscal problems, some predict that Puerto Rico is headed for a humanitarian crisis. The territory’s pensioners are one demographic perched at an uncertain crossroads. The island’s retirement administration, ASR, issues $73 million per month in pensions to government and judicial retirees. Under current conditions, the available allocated money could theoretically run out as early as late 2018. The ASR is still awaiting a government pledge to refund the ASR’s coffers under a 2013 reform. Still, this does not promise a full repletion, and would hence stave off the pension crisis only temporarily. The head of Puerto Rico’s government-employee pensioner association, Roberto Aquino, has expressed his deep concern at the continued reduction of pensions under Governor Rosselló and Promesa.

Acting as a financial counter-balance to the crisis, Puerto Rico’s International Insurance Center (IIC) has been luring foreign insurance companies at an increasing rate. It is likely that these insurers will continue to flock to the island in the fiscal year ahead. The attraction is mainly due to a regulatory framework which allows for the formation of protected cell companies (PCC). This is a mechanism by which a single legal entity holds separated assets and liabilities in multiple cells of the corporation, ensuring greater security in a fiscally volatile landscape. Director of the IIC and liaison with the Department of Economic Development of Puerto Rico, Rubén Gely, has predicted an increase from 400 PCCs in 2016, up to 600 by the end of 2017.

Debt restructure

Governor Rosselló, since assuming office on January 2nd, 2017, has already promised several austerity measures for the fiscal year ahead. These include the cutting of operating expenses by 10 percent, and the slashing of political appointees by 20 percent.  The belief is that these measures will grant the island greater leeway in current and subsequent negotiations with creditors. Nonetheless, creditors have become weary, particularly in light of the most recent debt restructuring deal between the Puerto Rico Electric Power Authority (PREPA) and its bondholders. This will see the restructuring of $9 billion of electric utility debt. Rosselló has called on bondholders to accept payment reductions of approximately 15 percent.

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Despite a rhetoric of austerity, on January 28th Rosselló signed a fiscal emergency law granting him authority to set aside money for “essential” government services, which would otherwise be allocated for debt repayment. The prioritization of services over G.O. debt has many creditors in fits of anxiety. Officials have pledged to place every expenditure through a “litmus test,” to ultimately determine the prospect for money reallocation. Bondholders should pay close attention to the fiscal turnaround plan Rosselló will present on February 28th, which will describe the new governor’s methodology on fiscal policy.

As the island awaits the unveiling of Rosselló’s economic plan, the fate of local bondholders remains in flux. Although, as a Bloomberg report affirms, there is little doubt that individual investors will wind up with less than they are owed, estimating that Puerto Rico could cover just $800 million, or 21 percent, of its debt service in 2019.

A curtain of opportunity has opened for a positive fiscal strategy, with Promesa’s oversight board demanding Rosselló’s plan generate $4.5 billion annually until 2019. However, many Puerto Ricans continue to suffer daily, hoping their governor will strain every muscle to ease their enchanted island’s fiscal burden without slashing expenditure to essential government services. A standing ovation is far from certain.

Categories: Economics, North America

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