Puerto Rico recently declared that it was $13 billion short of the funds needed to repay bondholders over the next five years. The Commonwealth is now trying to work with creditors and restructure some of its $72 billion in outstanding debt.
Puerto Rico’s debt problems are not new, but they started causing alarms a couple of years ago. Some of the reasons for the deterioration are the loss of a US tax break for mainland manufacturers in 2006, a real estate crash steeper than the one on the continent, and a shrinking population. Unfortunately, as tax revenues declined, government spending increased to make up for the deficit. As a result, between 2004 and 2014 Puerto Rico ran an average budget deficit of 15%. Making matters worse, earlier this year, Standard and Poor’s downgraded all of Puerto Rico’s debt to below investment grade citing the weak economy, high unemployment, and consistent budget deficits. (Does this sound eerily similar to Greece?)
Unlike states or municipalities, Puerto Rico is excluded from filing Chapter 9. It seems to be due to a technical error when the law was written, but the end result is that the island and its agencies cannot file for bankruptcy protection.
In June of 2014, the commonwealth tried to correct this problem and passed the Recovery Act. Ironically, in February of this year the federal court struck down the Act as unconstitutional for violating (of all things) Chapter 9 of the Federal Bankruptcy Code.
The risk of default is real. With lawmakers failing to set aside funds, Puerto Rico’s Public Finance Corp. missed debt-service payments for the first time in August and then again in September. Standard & Poor’s said that all of Puerto Rico’s tax-backed debt is highly vulnerable to default.
Since Puerto Rico doesn’t have the option of seeking a restructuring through bankruptcy, it has to go directly to bondholders for relief. Consequently, Governor Alejandro Garcia Padilla announced his five-year plan.
The Governor’s working group is seeking a restructuring of $47 billion of Puerto Rico’s bond debt. While the group did not specify which bondholders would have to take a voluntary haircut, the details are expected to be negotiated in coming weeks.
The plan also calls for an ambitious package of economic reforms enabling the island to deliver public services and collect taxes more efficiently, stimulate business investment and job creation, and carry out long-overdue maintenance on roads, ports and bridges.
Besides restructuring the debt, the plan calls for economic reforms to stimulate business and create jobs. It also proposes steps that include improving the Commonwealth’s infrastructure, collecting taxes more efficiently, raising the tuition at the University of Puerto Rico, seeking a waiver from increases in the federal minimum wage, updating the government’s software to better track expenses, cutting health care costs, and contracting for-profit companies to run government properties.
All of these measures require concessions, meaning the solution is nowhere in sight. Puerto Rico has a lot of work ahead of it to stabilize its finances and if the Greek playbook is any indication, the process is going to be long and drawn out.
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Washington Trust Bank.