After over 10 years of recession and poor fiscal management, Puerto Rico continues to face a major fiscal crisis now spurred on by the COVID-19 pandemic. With over $74 billion in debt, deeply distressed pensions, high unemployment, and outmigration, the need for an imminent debt restructuring is growing. However, is this the best resolution to solving Puerto Rico’s enduring crisis? [1]

Origins of the Crisis

The explanation behind how the Puerto Rican government amassed such substantial amounts of debt lies fundamentally in the island’s economic history; as the island is an unincorporated territory of the U.S., it has been subjected to experiments in tax policy, free trade, and has acted as a cash cow for U.S. corporations [2]. Investors in Puerto Rican municipal bonds had received favourable tax treatment for years and many bond investors from the U.S. capitalised on this. When a government issues bonds, it is effectively lending money, with interest, to bondholders. Overtime, Puerto Rico issued unsustainable levels of bond debt and began to rely on borrowed funds from bond issuance to balance its budget [3].

An economic fallout was becoming inevitable given that Puerto Rico is not a resource rich island nor is it predisposed for mass production of manufactured goods. Following President Bill Clinton’s elimination of the Section 936 of the Internal Revenue Code in 2006, in a bid to demonstrate a willingness to reduce corporate tax breaks [4], Puerto Rico was left shattered. Its economy was sustained for decades by the presence of technology and service-oriented companies including many large pharmaceuticals that were located on the island due to its favourable tax treatment and these companies as predicted, fled the island following the repeal.

Given these developments, real GDP began to contract severely. Between 2005 and 2013 real GDP declined by 15% worsening the island’s debt-to-GDP ratio [5]. In 2014, Puerto Rico’s debt was downgraded to “junk bond” status by S&P, after the government failed to demonstrate the ability to pay off its debt [6]. From 2003 to 2013 alone, bond debt increased from $29 billion to $71 billion as the government became a major employer due to severe private sector job losses [7]. And on January 4th 2016, Puerto Rico began to default on some of its bond commitments; bankruptcy was effectively declared on the 30th of June 2016 following Congress’ approval of PROMESA, a law that allows a U.S. territory to seek bankruptcy [8]. The territory’s subordinate political status makes it solely dependent on decisions by the U.S. Congress and federal courts.

This fiscal crisis has also been compounded by multiple natural disasters (Hurricanes Irma and Maria in 2017, and the 2019-2020 earthquakes) that have caused total destruction, especially on the main island of the archipelago [9].

The Debt Restructuring Deal

Puerto Rico has reached a deal with bondholders in February of this year to write off $24 billion in debt, moving it a step closer to exiting a financial crisis. The Financial Oversight and Management Board was created to help the U.S. territory dig itself out of a financial hole that began when it defaulted on some debts in 2015. It aims to turn about $35 billion of debt, into $11 billion of new bonds that will be repaid over 20 years. The deal will cut the Commonwealth’s outstanding bond debt from $35 billion to approximately $11 billion [10].

News of the agreement sent the value of $3.5 billion worth of debt borrowed in 2014 surging to nearly 75 cents on the dollar, its highest level since 2015. The oversight board has asked bondholders to accept a further $3.3 billion cut in payouts as a result of the coronavirus pandemic, a prospect they are so far refusing to accept, sending that bond value back down to 58 cents [11].

The creditors, who are pushing for a new restructuring plan by the 30th of November, have limited options. They are not able to sue the island or the board, but could request the judge overseeing the restructuring to lift the provision preventing litigation.

The Reaction to the Deal

The restructuring deal has unsurprisingly had a mixed reception. Bondholders are preparing to put up a fight however as mentioned before, it is unlikely to come in the form of litigation tactics. Nevertheless, despite the number of restructurings declining, an increasing share of them have involved lawsuits [12]. It is reasonable that bondholders such as Aurelius Capital, were trying to abolish the plan of Puerto Rico’s financial oversight board to restructure the island’s $124 billion in debt and pension liabilities, as they were likely to get only 64 cents on the dollar, following the previous 2019 Plan of Adjustment [13].

However, a group of investors holding bonds issued after 2012 issued a statement following the announcement of the February deal: “this settlement represents meaningful compromises on the part of all parties and is in the best long-term interests of the people of Puerto Rico.” Hedge funds Autonomy Capital and Aurelius Capital Management, which had previously battled the island in the US Supreme Court, are among those involved in that group [14].

Others have reacted by saying that it’s a bad deal because it will result in more contractionary fiscal policy, increasing taxes and reducing pension payments, education and social services and that the Puerto Rican’s are in no position to endure more austerity measures. Furthermore, the deal has faced criticism from Puerto Rico’s governor Wanda Vázquez: “my position during this process has been that if bondholders receive better treatment in a new deal, pensioners must also receive better treatment.” [15]

Whether to Debt Restructure or Not?

Senior Scholar for the Mercatus Center at George Mason University, J.W. Verret, views the debt restructuring as a violation of creditors’ contracts which provides an indirect bailout of a fiscally profligate lender [16]. He goes on in saying that it is not legitimate to repudiate, partially or in full debts that are purchased in the market and defined according to a contract even if they were purchased at a discounted rate. He instead suggests that a good initiative might consider making Puerto Rico the gateway to a repatriation of corporate profits maintained overseas to avoid the United States’ abusive corporate tax system. Therefore, Puerto Rico should seek to reform its tax and regulatory climates to foster economic growth.

Meanwhile Marc Joffe, a senior policy analyst at Reason Foundation, reasons that the triple tax exemption given to Puerto Rican debt, subsidised the increase in debt loads that pushed Puerto Rico into its current crisis and, as a result, bondholders should anticipate a reduction in interest rate payments or delayed principal payments [17]. Furthermore, with Puerto Rico locked out of the capital markets and unable to balance its books, the situation has become unsustainable and is now the subject of federal action in the form of Congress using its power to create a territorial debt adjustment regime for Puerto Rico as part of a larger reform package that includes stronger federal oversight. He finally suggests that if the present value of payments on Puerto Rican bonds are adjusted down to something approximating their current depressed market value (recently in the range of 50–70 cents on the dollar), fund investors will not experience further mark-to-market losses.

Meanwhile other scholars have suggested that some practical ideas to ensure the benefit of citizens rather than just creditors of debtor countries such as Puerto Rico, include increasing transparency on debt data and debt contracts, realistic economic forecasts that incorporate downside risks, and new legislation to support orderly sovereign debt restructurings.

In the long-run, Puerto Rico needs to find a path towards creating a self-sustaining economy that does not depend on outside investment, but encourages locally invested wealth creation. Ultimately this process requires reassessing the island’s colonial relationship with the U.S.

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