An Island Saddled in Debt Could Have Impact on U.S. Economy: Puerto Rico

Puerto Rico

While the economic crisis in Greece has garnered worldwide headlines, another island economy saddled in debt and facing defaulting on loans could have a big impact closer to home – Puerto Rico, the Caribbean commonwealth that is part of the United States. The recession in Puerto Rico has lingered for years, the population is tired of austerity measures and the once staid municipal bond market could be rocked when payment deadlines come and go without resolution this week.

The U.S. territory is reportedly unable to make payments on its more than $70 billion in debt. The financial markets, already grappling with the situation in Greece, could be rocked by higher borrowing costs for other governments trying to financial public improvements.

Puerto Rico’s debt is estimated at four time that of Detroit, which is the largest U.S. city to ever file for bankruptcy. Howeer, like states, the territory cannot file for bankruptcy. So, a failure to develop some sort of solution to buoy the economy and a new repayment plan – without the protection of bankruptcy court – could lead to uncharted waters in the financial markets.

The implications of Puerto Rico, which has a population of 3.6 million, not paying its debt will reach far and wide and could have an impact on the U.S. economy. Many mutual funds hold the island’s bonds. By some estimates, three out of four municipal bond funds have a Puerto Rican exposure, which at one point was considered attractive because they were exempt from taxes.

The financial crisis on the island has grown for decades, leading to a huge exodus of residents, slashed government jobs and pensions, raised taxes and taken other drastic measures to try to kick start the dormant economy. They cannot improve output, which is critical to increase revenues.

According to World Bank information cited in the Wall Street Journal, Puerto Rico’s debt-to-gross domestic product ratio is about 70 percent, far more than any U.S. state (Rhode Island and Massachusetts have the worst ratios at a little less than 20 percent). The average for the 50 states is well below 10 percent.

Throw in the declining population of Puerto Rico and its declining production per capita, and it is clear the territory has few options to improve its situation. They have kept going deeper into debt for years, in spite of all its efforts. At this point, the rating agencies have downgraded the commonwealth’s debt to near junk-bond levels, which means the interest rates they are paying are considerable.

According to officials, Puerto Rico plans to release an important financial stability report by leading international monetary fund economists on Monday that should acknowledge that the island’s debt are not payable. The New York Times said the report will propose a bond exchange with the new issues featuring a longer or lower debt service. The plan is that, given the reality of overdue payments and little means to bring them current, creditors will be asked to accept significant concessions, such as multi-year payment deferrals, in the restructuring. That may be the only means that creditors have left to allow Puerto Rico to deal with the debt with which it is saddled and avoid the island’s difficulties having a broader impact on the U.S. economy.

Written and edited by Dyanne Weiss

Wall Street Journal: Puerto Rico Has No Easy Path Out of Debt Crisis
Washington Post: Puerto Rico says it cannot pay its debt, setting off potential crisis in the U.S.
New York Times: Puerto Rico’s Governor Says Island’s Debts Are ‘Not Payable’

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